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“Did The Fed Just Tighten?”This is the hot new question more and more people are asking.
The reason people are asking that is this: Last week, the Fed announced that it was getting rid of its guidance that it would hold rates low until 2015, and that it would instead aim for low rates until unemployment was around 6.5% or inflation expectations were around 2.5%.
The growing chatter is that we could start seeing these thresholds before 2015, particularly if the economy gets out of the liquidity trap, and returns to trend or above-trend growth, as today’s GDP report suggests is beginning to happen.
That specific question ‘Did the Fed just tighten?’ is asked by BofA/ML’s Chief Investment Strategist Michael Hartnett, in his new note on “Contrarian thoughts” for the year 2012.
We find the change in the Fed’s “exit strategy” from its zero interest rate policy from late-2015 to an economic threshold of unemployment below 6.5% (and manageable inflation) to be very interesting. In our view, this brings into question the expectation that high liquidity is here to stay, and is perhaps a reason why gold prices have struggled this year. Also, since the Fed meeting last week, bond fund inflows have reversed. In just four days we’ve seen $2.5bn of outflows, which is on course to be the first weekly outflow in 30 weeks, and the largest outflow in 70 weeks.
This notion also helps explain some of the ongoing weakness in gold.
In a note out yesterday, Deutsche Bank’s Joe LaVorgna talked about the same thing:
As a result, if the pace of economic growth improves over the next year, the unemployment rate decline may accelerate from what has been a relatively linear drop to this point in the cycle. This is a risk to our forecast. In the following chart, we show the behaviour of the unemployment rate versus a fitted time trend. The close cluster of data points around the time trend shows the relatively linear drop in the rate; in other words, the rate has declined at a relatively constant rate. If this pattern continues, we should get to a 6.5% unemployment rate by Q3 2014. However, if the economy grows in excess of 2.5% in the latter portion of next year, compared to roughly 2% at present, the unemployment rate is likely to fall a bit more quickly, possibly getting to 6.5% in early 2014.
The fact of the matter is that people are really talking about an exit right now, or at least a possibility, in a way that hasn’t been discussed for a while. Arguably that fact represents a very modest tightening at the margins.