Add Deutsche Bank to the chorus of folks who think the Fed is NOT about to make some major dovish shift.Here’s the latest:
History strongly suggests we are on the cusp of a dramatic slowdown in productivity growth. Over the four quarters ending Q1 2010, productivity grew 6.1%, the largest gain in six decades. In the past, productivity has almost always slowed quite dramatically at this point in the economic cycle. Our forecast of a 0.3% Q2 increase lowers year-over-year productivity growth to a still robust 4.3%. As long as the economy does not weaken materially in H2, we believe an inevitable further slowing in productivity will translate into a faster pace of job creation.
Then, only after we experienced several large monthly increases in private employment, will market participants and Fed policymakers become more convinced about the sustainability of economic activity. In the meantime, expect the Fed to be on hold indefinitely. However, do not expect the Fed to make any changes to its balance sheet this afternoon. The improvement in financial conditions since the June 22-23 FOMC meeting (stock prices are higher, the dollar is lower and various credit spreads are tighter) as well as the fact the recovery is still proceeding— albeit slowly and unevenly—will embolden the Fed to keep policy on its present course.
And we won’t get even an improvement in language.
Consequently, we do not expect the Fed to symbolically announce that it plans to reinvest maturing mortgage backed securities back into the market. We do not expect the Fed to cut the interest on reserves either, as that would wreak havoc in the short end. Other than implicitly marking down its near term growth outlook, we expect the tone of the FOMC to not be substantially different than June. The Fed will retain its “extended period” language but will not see any need to qualify this any further. Only if H2 growth prospects were to significantly deteriorate from here would further attempts at quantitative easing be instituted.
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