The S&P’s earlier than expected downgrade to their outlook on U.S. sovereign debt may have sped up the austerity process, but it may also have slowed down the Fed’s exit from easy monetary policy, according to Societe Generale’s Rudy Narvas.
While QE2 now looks certain to end in June, the low interest rate environment will persist thereafter. FOMC members like Philadelphia Fed President Charles Plosser want a clear strategy for how to exit this easy policy environment, and they want it to start as soon as the end of 2011.
But the S&P outlook downgrade may have made it more difficult to accomplish, according to Narvas.
The outlook change does little to alter our near-term economic outlook; however it could have implications for 2012 and beyond. The S&P announcement could serve as a wake-up call for Washington and increase the chances that a compromise can actually be reached this year. If so, the fiscal drag on the economy in 2012-2013 would be greater than we had assumed, and the Fed’s exit could be delayed. Ironically, this means that the S&P move could actually prove supportive for the Treasury market in the medium-term. The dollar would be pressured lower in this scenario.
So while yesterday’s S&P announcement may force the U.S. to get its fiscal house in order, the Fed may be left as the only player, yet again, to stimulate the economy, and thus will have to act.