What Next, Big Ben?
This week’s announcement that Ben Bernanke’s Federal Reserve would up the ante in its purchase of debt securities has certainly made things interesting.
The Federal Reserve’s plan is to buy up to an additional US$750bn of agency mortgage-backed securities, bringing the total to US$1.25trn; increase agency debt purchases by up to US$100bn, to US$200bn; and grease the gears of the credit markets by buying US$300bn in long-term USTs. While the timing of this announcement was a surprise, this conforms with my view that if Bernanke wants to avoid deflation and get inflation, he can achieve it if he is aggressive enough in purchasing non-traditional securities. Inflation breakeven rates swung sharply higher in response to the Fed announcement, and could head higher yet if the market begins to believe that the outlook has gone from inflation to deflation to inflation in the space of a year. That is possible within the context of my ‘double-dip recession’ scenario, in which super-aggressive Fed action finally does result in reflation, but the economy eventually turns down again when the monetary authorities are forced to tighten policy in the face of resurgent inflation.
With nominal policy rates at zero, fiscal deficits rising and the Fed buying everything in sight, the natural victim is the dollar, which is suddenly looking very weak against the majors. In line with my short-term view, the euro has decisively breached resistance at US$1.33/EUR that I identified previously, setting up a further move to US$1.38/EUR.
What can you possibly do for an encore, Big Ben?