Is the Federal Reserve Right?

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Federal Reserve    At the recent FOMC meeting, Bernanke was not clear about timing and even course of the Federal Reserve in ending bond buying program.  Perhaps intentionally, his uncertainty created a lot of volatility in the market. Given this volatility, I think it would be very difficult for the Federal Reserve to signal any type of exit strategy without causing some form of market response. In a way, it makes Federal Reserve a hostage to the markets. The challenge for the Federal Reserve would be to persuade financial markets that it can exit without causing severe shock to the market and entire economy.

But is the Federal Reserve right in saying there is some positive economy growth in the United States?

There are three factors that drive US economy: employment, housing and automotive industry. The unemployment went down to 7.6%, but I think unless it goes to 6.5% the expansion will stall. Housing will be impacted by higher interests rates. Higher mortgage rates will slow down new permits for new construction, home purchases and building projects. So, the housing expansion that we saw over the past 12 month will level off. As far as automotive industry, car sales picked up the past month, because people weren’t buying cars in the past years. And we should expect automotive industry to be doing very well in the near future.

On a broader level, US needs the GDP to be over 3%t to sustain the growth, right now we are at 2.5%. We still have a lot of problems and declines in Europe and Japan, but US is improving. So, there are different interests rates on a global level.

I think the Federal Reserve is right that US economy is improving, but at a very slow pace. There is some positive economic data, but not enough for the Federal Reserve to act today. Most likely, the Federal Reserve will not end both bond buying program and raise interests rates at the same time. It will be done in gradual and cautions steps.

What to expect in the future?

Most likely, we will see volatility throughout the summer, because market scrutinizes each and every economic data trying to predict the timing of Federal Reserve. I think US interests rates rise will cause big sell off in bonds market. Stock market will have big adjustments and might go down. Once the interests rates go higher, gold and other precious metals will go lower. If gold will go below 1100, we will see major sell-off in gold. Oil may also go lower, because China is no longer expanding at the previous higher expansion rate and the biggest users of oil and gold are China and India . However, oil prices might be temporary offset by unrest is in the Middle East.

On a global level, US dollar will go higher than Euro and Yen, because again European economies and Japan’s economy are not as doing well as US. Both Europe and Japan are expanding slower than US economy.

Finally, don’t forget Eurozone troubles are far from over. Financial crisis in Cyprus still very much unresolved. The President of Cyprus wrote to European Union leaders asking for additional 10 billion Euros and to revise the terms of bailout. He explained that already provided finances are not enough and that Cyprus is a victim of Greek debt restructuring. Economic crisis in Cyprus escalating fast, causing deflation, falling retail sales, shrinking GDP and lack of capital. And of course, potential for Cyprus to leave Euro zone in the next 12 months increases tremendously.

The European Union did not respond yet to Cyprus, but the request might be denied. Now, what it means for Eurozone, is that Euro will get weaker again, unemployment is still very high in Europe. Demand for products such as cars the lowest in 20 years, which means European economies are very weak. Generally, it will bring us back to spiral downwards in Greece, Portugal, Italy and Spain, and again potential collapse of Euro Zone.     As far as everything, time will tell.

Anna Timone (195 Posts)


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