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Robust US Recovery to Keep Fed Doves Low

The composition of the Federal Reserve has undoubtedly changed in favor of the doves. However, the strong recovery in the US, and the already loose monetary policy will likely remain unchanged.  

David Song of DailyFX discusses the Fed, China’s landing, Spain’s edge over Italy, Britain’s safe haven status and one currency which still has a potential, even after making big gains, in the interview below.

David Song studied macroeconomic policies under a visiting scholar at the Federal Reserve Bank of St. Louis while attending the Zicklin School of Business at Baruch College, and graduated with a Bachelor of Business Administration degree majoring in finance. During his undergraduate program, David acquired a strong understanding of technical analysis from a former-president of the Market Technicians Association, and incorporates both fundamentals and technicals in his analysis. After starting at  DailyFX, David authors the daily briefings for the U.S. Open as well as the Trading the News report.  David Song

1) Do you think that the new composition of the FOMC will yield a different policy? Can the current state of the US housing sector justify action on mortgage based assets?

The new composition of the FOMC may sound a bit more dovish as central bank doves Sandra Pianalto, Dennis Lockhart, and John Williams join the committee. However, as the more robust recovery limits the scope for another large-scale asset purchase program, we will see the Fed carry out its current policy stance throughout 2012. As the zero interest rate policy paired with ‘Operation Twist’ continues to have a dampening effect on longer-term borrowing costs, the extraordinary measures may not be enough to jump-start the housing market but will surely help to encourage buying activity.

2) China reported yet another quarter of strong growth, yet home prices continue dropping, and global demand is slowing. Where is the economic giant headed?

Although China appears to be facing a ‘soft landing,’ the drop in foreign investments paired with the slowdown in global trade dampens the growth potential for the world’s second largest economy. As global growth cools, China is widely expected to extend its easing cycle in 2012 and the government may embark on a closed-door policy to prop up domestic demand.

3) Spain raised a lot of money in the markets, and enjoyed lower yields. Is this a result of the ECB’s LTRO? Italy has a larger debt-to-GDP ratio and higher yields. Can it catch up with Spain?  

The ECB’s LTRO certainly helped to bring down record-high borrowing costs across the euro-area as President Mario Draghi encouraged commercial banks to take advantage of the non-standard measure. Although short-term rates have come back from extreme levels, the stickiness in longer-term financing costs continues to raise the risk for contagion. For Spain and Italy, emerging from the economic slowdown will be key for both regions, but Italy may not be able to enjoy the relief seen in Spain as market participants expect to see a larger contraction in Italy.

4) Britain managed to receive a negative interest rate on 35 year bonds. Is this a sign of confidence in Britain and a positive sign for the pound? Or just an indicator of fear?

As Britain remains ahead of the curve in addressing its budget deficit, market participants will treat U.K. assets as a safe-haven as long as the Bank of England keeps the benchmark interest rate at the record-low. As the U.K. faces an increased risk of slipping back into recession, the BoE is expected to maintain a dovish outlook for monetary policy and it seems as though the central bank will maintain the 0.50% interest rate for a prolonged period of time as the MPC see an increased risk of undershooting the 2% target for inflation. For the British Pound, the shift in market perception should help to prop up the sterling, but speculation for more quantitative easing could dampen the appeal of the U.K. currency as the central bank keeps the door open to expand the Asset Purchase Facility beyond the GBP 275B target.

5) The New Zealand dollar was one of the best performing currencies in recent weeks. Do you think that the drop reported in consumer prices can soften the prospects for monetary policy and weaken the currency? Or are other factors more dominant?

Easing price pressures certainly limits the Reserve Bank of New Zealand’s to scale back the emergency rate cut from back in March and it looks as though the central bank will continue to endorse a neutral policy stance as the slowing recovery dampens the outlook for inflation. Indeed, the RBNZ held a cautious outlook for the region in light of the ongoing turmoil in the world economy and the central bank may keep rates on hold in an effort to stem the downside risks surrounding the isle-nation. However, as RBNZ Governor Alan Bollard expects the rebuilding efforts from the Christchurch earthquake to spur a more robust recovery, the central bank head may keep the door open to normalize monetary policy in 2012 and we may see the New Zealand dollar continue to outperform against its major counterparts as interest rate expectations pick up.

Yohay Elam

Yohay Elam

Yohay Elam: Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I've accumulated. After taking a short course about forex. Like many forex traders, I've earned a significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I've worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.