Global Macro Strategy second half 2011: Inflation outlook

In the previous post we postulated some of the main factors which can dominate the second half of 2011.
The factors are:

1. QE3 or not?
2. Interest rates outlook for Emerging economies.
3. Will Fed hike the rates in 2H 2011?
4. The persistent European problem.
5. High levels of household debt and
6. Double dip or not....


Lets have a discussion about how each one of the above will affect the undercurrents of the markets.


As of now Fed has said that they are not doing any QE3 and I am sure they will not start any other money printing  program by the name of QE3. The Fed is already buying the bonds from the proceeds of maturing securities. 
That amount is not much and is staggered so the impact will be minimal.


The dual target of Fed being Inflation and unemployment cannot be met through the QE program now. While launching the QE2 there were fears of Deflation which is why the Fed started the money press. Now the CPI is rising so much that the US has released crude from the Strategic Petroleum Reserves. 


About employment the Fed cannot do much as it grows with the GDP. Unless there is growth in real economy the will not be much employment. To grow an economy one needs policy and incentives which is job of an administration, any reserve bank cannot do much in that space. 


So we feel that there will not be any QE3 program unless the inflation gets tamed.


It is expected that Fed will start raising rates in 2nd Half 2011 but as of now there are no indication in that direction. In the last Monetary Policy assessment Ben said that he is looking for an extended period of low interest rates. It is through the low rates that the Fed can keep giving the stimulus to the economy. Although it is debatable as Japanese low rates have not stimulated their economy in any way. 
I feel that unless there is a pickup in GDP to above 3% for two quarters Fed will not raise rates.


The ECB meanwhile has given indications of raising rates again as there target is to control inflation rather than unemployment. 
Given the worries on sovereign scenario for many European countries it does not make a case for any steep increase in interest rates but another 25 bps cannot be ruled out as the German and France industry is in good shape.


The scenario is very different in the Emerging economies as some of them has already raised the rates as the fight against inflation is intensifying. India, Brazil, South Africa, Taiwan all have raised rates minimun of 3-4 times in past 1 year.


There are now talks from China and India that the interest rate rise might be over as Inflation is showing signs of peaking. I think that with crude down to $90 levels there can be for sure some cooling off signs in inflation. 
Vietnam has actually reduced their rates this weekend as the growth suffered a lot. 


What we can see is less raise in interest rate rise from here.


In short there is for sure signs of abating inflation as there is no QE from US and crude below $90 levels.
This can reduce pressure on Emerging economies not steepen the rates which can improve their GDP growth in next 3-4 months.


The developing countries on the other hand will raise rates esp ECB as they feel the inflation heat.


All this can reverse the money to EM stock markets which fled earlier this year on inflation outlook.


Rest in next part