Monetary Policy

Quantitative Easing
The profile of the US economy shows that it remains strongly leveraged, is experiencing a long
term slowdown of real growth and is an economy that has become increasingly deflation prone.
Since letting matters unravel of their own accord as happened over the 1928 - 32 period is not
a popular option, we are stuck with governmental policies designed to keep the economy afloat.
These have included a super accomodative monetary policy, bail out mechanisms for the troubled
financial sector and a liberal fiscal policy wherein lower taxes and higher spending levels have
been put in place to offset a sharp increase in private sector savings and private sector deleveraging.
(Banking system loan book).

The economy is recovering, but it is not yet clear it can sustain the recovery process. Unemployment
remains very high and the private sector has yet to resume a more normal pattern of credit demand
expansion. Political pressure and the urgings of a number of economists are pushing government
to end the policies of super monetary accomodation and the generous fiscal support. To make the
matter more complicated, markets have focused strongly on the Fed's quantitative easing program
to the exclusion of the broader picture of still falling system funding when you factor out the growth
of the basic money supply. Thus, there has likely been unnecessarily strong speculation in the
commodities markets which has pushed up inflation and which is making it more difficult for the
Fed to sustain its QE programs.

For my part, if US real growth is set to remain on the modest side and if total private sector credit
demand continues muted, I do not take strong issue with idea that the Fed might have to do
substantial additional QE in the years ahead. By the same token, QE tactical implementation
may have to be modified if the QE is indeed spiriting commodities speculation. Not to do so
could result in continuing QE which turns counter productive vis a vis economic growth. 

So, it could be the case that the Fed might elect to shelve QE again to see how the economy and
inflation behave. If they quit QE on 6/30 when the program expires, it could work out just
right. But if the economy begins to stall, we may find a return to QE again in 2012 on a more
modest scale. I must say in defence of the anti - QE crowd, that the Fed did inject such a large
amount of liquidity over the past nearly three years that policy implementation is running well
ahead even when compared to a reasonably aggressive long term QE program which could, say,
run out to 2020. Reserve Bank Credit

Looking out to next year, the Fed may also have to take into account what might transpire with
regard to fiscal policy. My inclination is to think there will be plenty of big talk in DC, but
that spending constraints and tax increases might not kick in until 2013, if then. If there is
a genuine thrust to reduce the budget deficit over the next year or two, the Fed might also
have to consider saving some QE "ammo" for that time.

Fed Funds Rate
My indicators are now running about 80% in favor of having the FOMC elect to lift the FFR%
target rate. If the economy continues to progress and the fresh uptrend in business short term
credit demand remains on track, the indicators will be 100% on the side of having the FOMC
lift rates by late in the year. Moreover, if QE is put on the shelf after 6/30, the Fed will have
leeway to temporarily drain reserves to foster an FFR% hike if it so chooses. This would mark
the first time in over four years that the Fed would be in a credible position to pull the trigger on
raising Fed Funds.