The Fed decision last night was not expected to rock the boat, but the subtleties cannot be ignored given the reliance of many asset markets upon the Fed’s continued easy money stance. There was a subtle upgrading of the Fed’s growth outlook, the statement acknowledging an improvement in the longer-term picture.
Although the Fed’s commitment to keep “exceptionally low levels” for rates until late 2014 remains, the charts released with the statement show a notable proportion of the non-voting members are looking to raise rates earlier. This is ensuring that the debate remains healthy at least. Markets proved relatively resilient to the Fed Chairman’s remarks, although the dollar does stand modestly softer against most major currencies since the meeting results.
Guest post by Forex Broker FxPro
In a relative sense, the US continues to stand out from the pack in the developed non-Asia world, especially in light of the UK GDP numbers yesterday and the likely weakness in Q1 eurozone data in the coming few weeks.
Commentary
UK recession is not the issue. Yesterday’s numbers confirmed it, but recession is a fairly arbitrary distinction, not least given that the anticipated 0.1% quarterly increase would still have left output lower vs. six months ago. One of the factors dragging the economy down was the construction sector, which contracted a further 3.0% on the quarter. This sits slightly at odds with the construction sector PMI data, which displayed a fairly strong recovery in March (from 54.3 to 56.7). No doubt this will bring about questions regarding the accuracy of the official data and it’s true that these figures do get revised quite substantially, but for now these are the ones the government will have to live with and plan by. It’s fair to say that the UK economy has mostly been stumbling over the past two years, rather than recovering. Over that time, the economy has contracted for just as many quarters as it has grown. This further undermines the distinction between being in recession or not. The fact remains that the UK economy is still 4% below its pre-cycle peak whereas Germany and the US have both surpassed theirs. For the Bank of England, this puts it once again in the position of having under-estimated inflation (which is falling more slowly than anticipated) and over-estimated the economy. For the government, there will be renewed questions over the suitability of fiscal tightening when the economy remains so anaemic as well as the political flack. It’s notable that sterling, has regained all of the post data dip vs. both the dollar and (just about) the euro, but testing times are ahead, especially as the Bank of England releases its latest Inflation Report next month.
Hollande gauntlet thrown down to Merkel. Germany’s austerity doctrine has been under renewed assault this week in a clear sign that political opposition In Europe to perpetual financial discipline is wearing thin. On Monday, Dutch Prime Minister Mark Rutte resigned after Geert Wilders pulled his Freedom Party out of the ruling coalition because of disagreements over the extent of fiscal consolidation. In France, Socialist Presidential candidate Francois Hollande has vowed to challenge Angela Merkel’s crisis strategy, by re-negotiating the fiscal compact and demanding that the ECB do more. He has also promised to focus policy more on growth than austerity. For its part, Merkel’s CDU has been fighting its corner this week, with the Chancellor reiterating that “you can’t spend more than you take in”. Much as Hollande and most of the electorate might not want to hear it, France must make some very tough choices over coming years to rectify its excessive deficits and public debts. Should Hollande emerge victorious on May 6th, and then carry through with his threat to push-back on austerity, then French bond yields must climb and the single currency would likely suffer.
The politics of austerity. If the past two years have shown us anything, it’s that incumbents are vulnerable, but also that honeymoons are tremendously short for newcomers. Once their feet are under the table, the budget and economy numbers are generally the same, or if not worse given the limited opportunity to adversely affect the budget numbers and blame the previous administration. Greece started the ball rolling back in 2009 with the Pasok-led government formed late in the year uncovering fairly major holes in the budget (and we know what that led to). More recently, Spain’s incoming administration received the biggest majority for nearly 30 years, removing the incumbent socialists. This was meant to give it the mandate to push through the required austerity to appease markets. So, in light of recent events in both France and the Netherlands, where does this leave us? Is this the great austerity backlash? Not necessarily. For incumbents, most elections are lost rather than won. Witness the softening in rhetoric from France’s Hollande, who initially declared war on the world of finance but has since seemingly softened his tone as victory has appeared more likely (at least to him). After all, with more than half of French government debt held overseas, it’s not a war that France can afford to fight. Furthermore, France’s history is that of a troubled yet symbiotic relationship with the world of finance.
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