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Capital Markets

Yet-more QE from the US Federal Reserve as fiscal austerity looms - SocGen

It's not just the eurozone storm and lacklustre growth. Société Générale reckons further easing from the Fed will kick in thanks to the prospect of fiscal austerity, a potential game-changer for monetary policy calculations.


With recent data supporting US Federal Reserve chairman Bernanke''s concerns on the job market - the Labor Department announced yesterday that weekly unemployment benefit applications rose by 6,000 to a seasonally adjusted 386,000 - speculation that the Fed will embark on more monetary stimulus  is rife.


But that''s only half the story. The elephant in the room is the prospect of fiscal austerity in the coming years, which will force the Fed to act further, SocGen reckons:


"Moreover, the Fed has to take into account the budget as the fiscal cliff looms: the more the US government opts for austerity, the more the Fed will have to ease to offset the impact on the budget. We will thus look closely at the new Fed projections, to be released at the 20 June FOMC: any downward revision to the GDP path outlook would argue for further Fed QE.


Ultimately, easing is a matter of when not if:

"QE3 is just a question of timing: our US economists think the Fed will increase its assessment  of downside risks given the events in Europe and deliver another injection of stimulus."

SocGen''s US economists are predicting that the Fed’s balance  sheet will increase by about $600 billion, with purchases spilt 40/60% between mortgage-backed securities (MBS) securities and US Treasuries. This is expected to be sterilized through term deposits and reverse repos  to reduce inflationary pressures.


The market impact is expected to mirror that of QE1 and QE2. SG reckons Operation Twist is balance sheet neutral - with the outlook bullish on 10 year swap rates and bearish on the dollar.


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