Monetary Policy

The case for raising short term interest rates based on well established long term standards is
weakening. Since the autumn, business new order strength has moderated as has manufacturing
activity. Plant operating rates have fallen as capacity growth remains at a 3.1% annual pace
while output growth has moderated. My short term supply / demand pressure gauge stands at
a moderate +4.3 in favor of demand and is down from late last year because private sector
liquidity has accelerated. Bank deposit growth has been sufficient to offset a recent reduction of
$20 bil. in Fed Bank Credit without roiling the short end of the market.

Some of the easing of economic demand reflects anticipated adjustment to the close out of the
QE 3 program and some of it comes as a result of severe winter weather in the eastern portion
of the US. Spring arrives this weekend but we here in the east have been moving from ultra-
winter to just plain winter.

The Fed now awaits seeing whether a spring thaw brings more vigorous economic activity or
whether the economy has lapsed into a slow growth rut. The benefits of the huge QE program
are on the wane, but private sector credit availability is on the rise and the banking system is
still nicely liquid.

With inflation having decelerated substantially over the past three years, my super long term
3 mo. bill fair value yield model suggests that the Bill should now be yielding only 1.5%. From
this low base it may be the case that if the economy rebounds as the year progresses and
inflation does not accelerate dramatically, the end to the Fed's ZIRP need not produce a large
surge in short rates.

As a growth oriented player, I am hoping the transition from Fed quantitative ease to private
sector credit generation works relatively smoothly. The hard data now supports a solid
transition, but that does not cover a very key variable: private sector confidence that the
economy can carry on. The few past episodes in US history of transitions from quantum Fed
easing to dependence on the private sector have not worked out well with the sustainability
of confidence the weak link. So, we hope for the best.