What Now?

by Chris Sturr | December 05, 2008

Hongkong and Singapore Bankcorp (HSBC) post-employment report policy outlook from Across the Curve

Not for the faint of heart.

More from HSBC On Fed and Economy
December 5th, 2008 11:00 am

US Economy – Change of forecasts; cutting growth and inflation; zero funds rate now expected on 16 December

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5 December 2008

* Timing of zero Fed funds call now 16 December, was 2009 Q2

* 2009 GDP growth forecast cut to -0.7% from +0.2%

* Core PCE inflation 2009 forecast cut to 1% from 1.3%, 2010 cut to 0.7% from 1.6%

* 10-year Treasury rate target cut to 2.0% from 2.9%

POLICY FIREWORKS SET TO INTENSIFY

Fed Chairman Bernanke has signalled that unconventional policy options, including aggressive quantitative easing and yield curve manipulation, is about to intensify, and as such, we now expect the Fed to cut the Fed funds rate to zero percent at the 16 December meeting, giving it a freer hand to conduct aggressive balance sheet expansion. If we are right, the December statement may also signal that the Fed is prepared to keep short rates down for a considerable period. If we are wrong and the Fed cuts 50bp or 75bp instead, we then would still expect the funds rate to be cut to zero on 28 January 2009.

Based on our forecast of an 8.8% unemployment rate by 2010 (up from 8.0% previously), we think the Fed will not have to raise rates until 2011 at the earliest. This, together with the Fed making aggressive purchases of Treasuries and mortgage backed securities at the long end, is likely to drive 10-year Treasury note yields to 2.0%, eventually taking the 30-year mortgage rate to about 4.0%.

Generally, we have taken an axe (yet again) to our economic forecasts (see table). GDP is expected to decline 5% annualized in Q4 (was -3%), -2.2% in Q1 (was -0.8%), before recovering back into positive territory from the second quarter, as we assume a USD600bn Obama fiscal package begins to hit the economy. We don’t know exactly how big the stimulus will be, but we know it will be large; probably USD600bn and some have talked about as much as a USD1trn package

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