Fed Tightening? Give Us a Break!

By: Axel Merk | Wed, Dec 16, 2009
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At the end of its scheduled two-day meeting, the Federal Reserve's Open Market Committee (FOMC) confirmed it will leave its target range for the federal funds rate unchanged and is on schedule to phase out various special liquidity programs. The Fed also confirmed it will continue to buy mortgage backed-securities (MBS) and expects to gradually slow the pace of these purchases; the Fed expects the entire $1.25 billion of MBS purchases to be executed by the end of the first quarter of 2010.

Numerous observers have pointed out how this is a sign that the Fed is about to tighten access to credit. With due respect, this may be plain wrong. When the Fed engages in security purchases, be they MBS or government bonds, the Fed is increasing its balance sheet, thus adding a permanent stimulus that will remain unless withdrawn or otherwise sterilized. The Fed is not only keeping its bloated balance sheet, but expanding it further until the end of the first quarter of 2010.

The FOMC states: "With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the committee expects that inflation will remain subdued for some time." In our assessment, this is about as clear as the Fed will ever be that there is no intent on tightening anytime soon despite recent signs of an economic pickup. The reasons given are resource slack and longer-term inflation expectations:

Specifically, note that the Fed does not list improved economic and financial conditions as a condition to tighten, but only as a reason to phase out additional liquidity facilities. The Fed's balance sheet, when adding MBS purchases and commitment to buy securities, net of phased out liquidity programs, has continued to grow.

As a result, it seems that the Fed may indeed halt the massive balance sheet expansion at the end of the first quarter of 2010, but such a break is not indicative of tightening, but a pause at an extraordinarily accommodative level.

In our assessment, the Fed is continuing to ease at a time when the European Central Bank (ECB) has already withdrawn liquidity and central banks ranging from Australia to Norway have raised interest rates. It seems rather unlikely to us that the Fed will have a tighter policy than the ECB in 2010. Of course, the eurozone faces challenges in Greece, Ireland and Spain, amongst others; but the U.S. will also face substantial headwinds, for example, commercial real estate. Ultimately, the global tightening wave many market observers are predicting in 2010 may be far weaker than priced into the markets.

 


 

Axel Merk

Author: Axel Merk

Axel Merk
President and CIO of Merk Investments, Manager of the Merk Funds,
www.merkfunds.com

Axel Merk

Axel Merk wrote the book on Sustainable Wealth; peek inside or order your copy today.

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

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This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Merk Investments LLC makes no representation regarding the advisability of investing in the products herein. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice and is not intended as an endorsement of any specific investment. The information contained herein is general in nature and is provided solely for educational and informational purposes. The information provided does not constitute legal, financial or tax advice. You should obtain advice specific to your circumstances from your own legal, financial and tax advisors. As with any investment, past performance is no guarantee of future performance.

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