Week In FX Americas: To Taper, The Hill And NFP To Decide

by: Dean Popplewell

The pace of recovery in the U.S. is at best softer, but not as precarious as it is in Japan or regionally uneven as it is in Europe. The bigger question is about economic sustainability, and that has been clearly answered by the Federal Reserve with its dramatic "no taper" move this month.

Blindsiding most capital markets, U.S. policymakers refrained from adjusting their $85 billion monthly bond buying of Treasuries or mortgage-backed securities. In doing so, the Fed cited various reasons from the political standoff on Capitol Hill to concerns about longer-term interest rates rising. U.S. bond yields have been backing up ever since Fed Chief Ben Bernanke announced last May, under the guise of better communication and transparency, that reducing market liquidity, or QE3, would soon be a part of that equation.

To Bernanke's credit, he never once suggested a liquidity tightening event commencing time schedule; the market took it upon itself to price in a reduction in liquidity in September. Mind you, no U.S. policy member ever went out of their way to dissuade capital markets that a token taper would commence in September. However, we have heard a few Fed heads imply something different this week. Any future notion of tapering will, in all likelihood, become a meeting-to-meeting call once again, beholden to a handful of economic data points, market developments, and most certainly a safe passage through U.S. fiscal legislation.

The Fed is correct to be hesitant at this juncture, however. Global growth is shaky at best, and turning the liquidity taps too tight too soon would have a huge global domino effect. U.S. data is proof that there is no need to tighten liquidity just yet. Personal consumption and corporate spending remains an issue. North American domestic and global inflation is a non-issue. Cheap credit has yet to consistently filter through the "system" and promote stronger economic growth. There is no housing boom in North America; there is a flood of cheaper houses, but the lack of higher disposable incomes and new jobs are not consistent. Corporations are not hiring en masse -- they are concentrating on increasing productivity and not spending. Even for consumers the access to cheaper credit has become more constrictive over the last few years because of tighter regulation. Perhaps next week's NFP will paint a clearer picture for investors.

The American economy may be heading toward another "fiscal cliff" crisis if the U.S. government hits its debt ceiling in mid-October instead of December. This time there is no backup plan. Now that the Fed's taper decision is out of the way and Bernanke is pointing a finger at Capitol Hill, a repeat of last winter's shenanigans between the Democrats and Republicans will be to blame.