After a big month for the equity markets, it was a relatively quiet week. Ongoing skirmishes in the Ukraine kept a cap on the enthusiasm despite relatively dovish statements made over the last weekend at Jackson Hole and a positive revision to US Q2 GDP a few days ago. We sat down with the Chief Economist from research firm Strategas (Don Rissmiller) to discuss how the economic world is evolving at this point. The first topic of discussion was the Fed and its path going forward. While the path looks clear on tapering coming to an end in October, the big question on investor minds is “what is next?” As opposed to the original plan set forth by Bernanke in 2011 whereby the slowing of bond purchases would be followed by stopping the replacement of existing bonds on the Fed balance sheet before moving to the interest rate increase, subsequent communication from Bernanke and Yellen seems to place an interest rate increase before the shrinking of the balance sheet. Don’s read is that there is much more “science and knowledge” around the likely effects of an interest rate increase relative to changing the balance sheet. We are hard pressed to say that there can be any expectation of precision (implied by the word science) in what comes next in monetary policy. Either way, we have a financial market that is likely to overreact and a central bank that does not want to “mess up a good thing.” Unlike a typical cycle where it takes “three steps (up in rates) before a stumble (in the equity market)”, he thinks that it is likely that the stumble would come before the actions. Yellen has indicated that we are also likely to get a clearer path before tapering ends in October, so we will see whether he is right in the near future. Our expectation is that any action is likely to be incremental (read small). In this uncharted terrain, it is best to tip toe out to be sure the ground can support the weight.
On Europe, Don was more circumspect. He acknowledged that the ECB is likely to follow through on some form of asset purchases if only because their credibility is at risk. The “it will be enough” comment was a few years ago now. Even though he continues to reference action, it is generally non-specific. As we said in an earlier write up, it has come to where action is needed. At this point, however, Don stated the obvious – monetary policy buys time, it does not solve the problem. To this end, he sees fiscal policy as being a key ingredient to making a recovery sustainable. He does not see the ability for the 17 nation Euro-zone to come together and deliver a fiscal solution. On that point, we politely disagree. We fully acknowledge the difficulty in coordinating and aligning the amount of bureaucracy in Europe. But we also acknowledge a universal truth – politicians like their jobs. If they want to keep their jobs, they have to stop thinking austerity and start thinking about ways to get unemployment down lest they soon join the ranks. The lingeringly high unemployment rate can serve as a unifying force to bring fiscal action, whether it be coordinated or not. French President Hollande’s recent reconstruction of his cabinet and comments calling for Europe’s leaders to focus on growth oriented fiscal policy is just a recent example. It remains early days, but we expect more movement in this direction.