As for another round of QE, this will likely depend on the employment data over the coming months. The Fed appears biased to increase its asset purchases as the economic situation is “far from satisfactory”, yet with the current Operation Twist program running through the end of December, the Fed may wait until later in the year before another expansion of its balance sheet.
Unemployment rates are key, in our view – it would require a move below 8% to stay the Fed’s hand.
The general election campaign is now getting under way and the polls see a tight race for President. The outcome will be hugely significant, not just for the policy stance early in 2013 (the infamous fiscal cliff issue) but for the longer-term direction of public policy around entitlement reform and taxation.
A Romney victory is seen as business friendly as the burden of adjustment falls on government spending. The market consensus expects the status quo to be retained – President Obama for a second term; no blocking majority in the Senate; and Republican control of the House of Representatives. That would likely see much of the potential fiscal drag postponed.
A sharp sell-off in treasuries brought on by another downgrade by Standard and Poor’s would certainly focus politicians’ minds.
The deficit, although still at a high 7% of GDP, is gradually declining as earlier programs expire and defence spending cuts kick in.
The bigger issue is the renewed uptrend in the baseline spending forecasts later in the decade as the population ages and healthcare costs continue to rise. Eventually, we believe the overbearing social programs will need reforming but that is unlikely in the next 12 months.
A lower probability of QE3 in the near term might suggest the low point for ten-year US treasury yields has passed.
If growth holds around 2%, we would expect a gradual steepening of the US yield curve; a significant advancement in US equities to record highs would likely be delayed.
