Quantitative Tightening

The emerging market economies of the world are taking tightening steps, in part to offset the effects of the U.S. Fed's "quantitative easing".  Yesterday Australia raised interest rates by 1/4% to 4.75%.  Australia is widely viewed as a proxy for China given their commodities exports to the Chinese.  India has also raised rates with their central bank rate for short-term funds now at 6.25%.

These countries are worried about capital flows from the U.S. (and other developed markets) being enhanced by the increased liquidity from the anticipated next step of  Fed quantitative easing.  As capital flows to the emerging markets it will cause inflationary increases in all goods.  Increased interest rates and increases in their currency relative to the U.S. are two ways these emerging economies can fight inflation.

All of this reminds us that the effects of any market or policy changes are global.  The key for investors is to keep this global point of view in mind as they make portfolio decisions.

U.S. 4th Quarter 2009 GDP Growth Surprises at 5.7%

The Commerce Department announced their "advance" GDP growth rate for 4th quarter at 5.7% this morning.  Expectations had been around a consensus number of 4.5%, so this was a positive surprise.  Much of the strength came from cyclical recovery in inventories (i.e. companies quit letting inventory levels just decline and instead increased production to replenish inventories).

While GDP 4th quarter strength is a plus, it comes against the backdrop of significant structural challenges in the U.S. and worldwide economies.   Examples of these challenges are timing and methods of removal of low interest rates and other stimulus by the Fed, possible long-term increased savings (and resultant consumption reduction) by U.S. consumer, and effect of eventually addressing U.S. and other developed countries budget deficit.

We'd conclude these comments with applause for today's GDP announcement accompanied by recognition that the private sector will need significant strength and resilience as we address a variety of sizeable challenges.

Federal Reserve members don't all agree as to future stimulus

Today the Federal Reserve released minutes of the meeting of the open market committee held December 15-16, 2009. It was interesting to note in these minutes that "a few members" were concerned about planned withdrawal of stimulus via ending purchases of securities related to the mortgage market and "observed that it might become desirable at some point in the future to provide more policy stimulus". Contrast this with somewhat the opposite view held by "one member" who "thought that the improvement in financial market conditions and the economic outlook suggested that the quantity of planned asset purchases could be scaled back, and that it might become appropriate to begin reducing the Federal Reserve's holdings of longer-term assets".

We have written before how challenging it will be for government policy makers to determine how and when to remove stimulus. The Federal Reserve minutes just demonstrate that there are a variety of opinions even among those key policy makers on how to proceed. Getting this just right will be almost impossible. We continue to be of the opinion that the U.S. government will err on the side of overstaying stimulus, thus laying the groundwork for future inflation; however, this all remains to be seen. The potential for some type of policy mistake would seem to be quite high.