Prospects for the Fed, the Presidential Election, and the Dollar

The jobs report released on Friday was not good.  Furthermore, when one examined the decline in the unemployment rate to 8.2 percent, one saw that the rate fell, not because the labor market was getting stronger, but because the number of people actively seeking jobs declined.  That is, the labor market shrunk…under-employment rose. 

Immediately, speculation grew about whether or not the Federal Reserve would go in for another round of monetary easing.

This discussion closely follows upon the conclusions that the Fed would not engage in any more quantitative easing following the recent meeting of the board of governors of the Federal Reserve System and countless speeches and lectures from the Fed Chairman. (http://seekingalpha.com/article/467561-ben-bernanke-please-understand-me)

It is my view that the Fed will not engage in another round of monetary easing in the near future unless the economy or the banking system or the international financial system experiences a major shock.  A “not-so-good” report on the labor market will not be the trigger for such an injection.

The economy is growing, although it is not a very setting the world on fire. (http://seekingalpha.com/article/469671-gdp-growth-the-road-ahead-and-the-investment-climate)

The banking system is quiet and although commercial banks continue to disappear either through acquisition or FDIC closure, things seem to be peaceful with no expected surprises here.

Deleveraging in the private sector continues and restructuring continues to take place in housing, state and local government and the labor markets.  Again, there are no expected surprises in these areas.

And, it is a presidential election year.  It is highly unlikely that the Federal Reserve will engage in any actions that will leave it exposed to the criticism that it is playing politics.  In reality, Mr. Bernanke and the Fed has done about all it can to create a favorable economic climate in which President Obama can get re-elected. 

Given the lag-in-effect of monetary policy, there is very little that the Federal Reserve can do at this time to change the trajectory of the real economy before the election takes place in November. 

Therefore, I expect that the Federal Reserve will conduct a very benign monetary policy over the next six- to nine-months. (http://seekingalpha.com/article/472291-the-federal-reserve-was-quiet-in-q1-but-stands-ready-to-do-more) Otherwise, it will open itself…even more…to charges that it is playing politics and supporting the incumbent president.

Of course, the Fed cannot stand by if there is a crisis somewhere in the economy…in the banking sector…or in the financial markets…or somewhere else.  In such a case, the Fed will respond quickly and with sufficient force to avoid any breakdown.

Otherwise, I believe that the Fed will avoid any new initiatives this year.  Short-term interest rates will remain low.  The demand for money is weak and the Federal Reserve statistics indicate that there have been no new actions on the part of the Fed to keep them at current levels. 

If the real economy does pick up some speed and the demand for money begins to increase, some pressure may start to build for these short-term interest rates to rise.  My guess here is that if this scenario starts to develop, the Fed will allow these short-term rates to creep up.  In such a case, the Fed will not engage in a real active campaign to keep them in their current range. 

The key here is that the pressure for rates to rise will come from an economy that is strengthening.  This movement will be looked on positively by Federal Reserve officials.

The interesting market reaction to the Fed’s indication that it would not engage in another round of quantitative easing was that the dollar began to strengthen against the euro.  Through Thursday, last week, the dollar price of the euro had almost reached $1.30. 

Friday, with the release of the jobs report and the speculation that the Fed might engage in another round of quantitative easy, the dollar price of the euro rose slightly. 

This morning, the dollar rose again against the euro and I believe that this will continue if the Fed continues to maintain its current monetary policy stance through the spring and summer of this year.  In fact, I believe that the dollar will crack the $1.30 price against the euro and will continue down as the European Central Bank (ECB) continues to follow its present policy position.  (For more on this see my earlier post about the dollar breaking the $1.30 price level earlier this year: http://seekingalpha.com/article/371691-the-euro-drops-below-1-30.)

The dollar will continue to appreciate against the euro if the Fed continues to keep things pretty much the way they are at the present time because Europe, in my mind, is still in the middle of a mess.  One only needs to mention what is going on in Spain and Italy and Portugal...and then there are the French elections that we must go through over the next couple of months.

So, I see the Fed remaining relatively quiet for a while (except for Mr. Bernanke’s efforts to inform the world on what he and the Fed have done over the past five years or so); I see the economy continuing its recovery; I see some pressure starting to build on short-term interest rates; I see the value of the dollar rising against the euro; and I continue to hope for the absence of any unfavorable shocks to the world. 

If we can achieve this over the next year I believe that we will have been very fortunate.