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Financial Repression, the Fed and the Euro

Posted by Joseph Trevisani on Jun 11, 2013 12:35:00 PM

Is the Fed is becoming concerned about the negative effects of prolonged artificially low rates?

It is no coincidence that Fed board members and Chairman Bernanke are going public with their concerns about quantitative easing. Nothing said by a central banker is off the cuff. Fed minutes are edited they are not transcripts. Transcripts are embargoed for five years.  The editing is intended to reinforce the deliberate communications of the Fed Chairman and board. Fed minutes are not revelatory they are policy documents.

The chief current worry and debate at the FOMC is that the extended low rate policy in place since August 2011, first to  below 2.5% and then in April 2011 to below 2.0%, is starting to do more harm to the economy than good.

For example--the Case/Shiller Home Price Index was up 10.87% y/y in March. In an economy with 7.6% unemployment, 13.8% underemployment, no wage growth and negligible inflation does this make sense? Saying that the housing market is still below the 2006 peak is silly, since when is a bubble peak a good reference? Housing prices are higher because investors have bought properties in large numbers for resale. This is good and how markets clear, but it is not a sign of economic recovery. Resale and purchase by a homeowner is the positive economic indicator.

In the currency markets do not always look for sensible economic explanations for day to day or even week to week moves. Markets and traders tend to keep to a view until something dramatic comes along to change it, and then the mad rush begins.  Right now the idea of about two weeks ago that a Fed tightening cycle was next, if not quite imminent, has been put aside, so the euro is higher. But it has not broken out of its range, though it is over the 1.3200 level that was the top going back to February.

The Fed has led the way for all central banks on low rates and QE, and they are doing so again. At some point, and we are at or near that point, financial repression becomes economically repressive, distorting the normal risk/reward calculation in an economy and inhibiting growth. Starting a business is risky. It is hard work and often fails but that is where most job growth comes from.

So back to the euro. If the Fed is beginning the long pull back to normal rates, then the dollar will have to follow.

Joseph Trevisani

Chief Market Strategist


Charts: Bloomberg

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