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'If Its and Buts Were Candy and Nuts, It Would Be Christmas Every Day'

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This catchy little aphorism was House Speaker John Boehner's answer to reporters' questions on Thursday, regarding the likelihood of a near term deal to get America's government back to work and to raise the debt ceiling, which is officially due to expire on 17 October. His point being that there was still a way to go before agreement could be reached.

As I write (Friday 11th), the talk is of a short-term bill which would do both, but the Republicans haven't abandoned hopes that they can come out of all this having forced reductions in spending, (maybe even on Obamacare), and agreement to tax reform. Although they might send a so-called 'clean bill' extending the debt ceiling to November 22nd to the Senate, which would be acceptable to the Senate and the President, they also want to tie agreement to re-opening the government, via a Continuing resolution' (CR), to a successful conclusion to the spending and tax negotiations. The President has said he won't yield to threats and he's unlikely to agree to negotiations without a 'clean' CR. So, 'there's many a slip twixt cup and lip' to quote a somewhat older aphorism with the same meaning as Boehner's.

Washington's impasse can be having nothing but detrimental effects upon the real economy. Consumer sentiment is certainly taking a hit, according to the daily Rasmussen Survey of same, which has fallen off a cliff-

10-Oct TH 90.9
09-Oct WE 92.0
08-Oct TU 93.1
07-Oct MO 93.1
06-Oct SU 95.2
05-Oct SA 95.7
04-Oct FR 96.8
03-Oct TH 100.3
02-Oct WE 101.2
01-Oct TU 103.0

90.9 takes us back below average readings last seen in November 2012.

With an economic data vacuum in the States, which will surely now last for several more days or weeks, and the release and integrity of the key unemployment report for October also called into question, (never mind September's, which has already been delayed by the Federal shutdown), the Fed is going to have scant and dodgy data to hand at best when it meets in December, having had next to nothing for the October meeting.

I'm beginning to feel that any taper decision on the Fed's Quantitative easing programme is going to be pushed into 2014, due to this and to the new Chairman's accession in January.

Let us now turn to Ms Yellen, for she will surely be the new Chairman. The other change in January will be the annual rotation onto the FOMC of four new Regional Fed Presidents as voting members. Uncomfortably for the uber-dove Yellen, the newcomers are of a distinctly more hawkish hue than those departing. On the other hand, one of the Governors of the Federal Reserve Board, (who are permanent FOMC voters for their full 14-year terms), Jerome H. Powell, leaves at end January, and he leans more towards hawkish judgements than dovish. Appointment of Fed Governors is the President's gift, but in a Congressional election year he will want to select a suitably dovish replacement, and we know the type of candidate that Yellen will propose if he consults her, as one would assume he will.

The minutes of the last meeting reveal a cautious and extremely divided FOMC. Why did they decide not to taper? To quote the minutes, "a number" of participants highlighted "risk management considerations"; also economic data had been "on the disappointing side." They were therefore worried about tightening financial conditions, given the effect it was having on the housing market, and they were also concerned about the considerable risks around fiscal policy.

There was also discussion about the need to bolster the forward guidance on when interest rates may be raised, as the FOMC realized that QE tapering expectations had become too intertwined with the eventual rate rise decision, hence, "it might be important to reiterate the distinction between the two, and a clarification or strengthening of the forward guidance might help to reinforce that message." One can assume discussion centered on the idea of tying the 6.5 percent unemployment threshold to a specific measure of inflation, maybe the introduction of a lower bound to inflation, and maybe even a lowering of the unemployment threshold. The change in Fed Chairman was also considered important to "the appropriate timing of any enhancement to the guidance."

It is instructive to look at a couple of recent Yellen comments-

"With employment so far from its maximum level and with inflation currently running, and expected to continue to run, at or below the Committee's 2 percent longer-term objective, it is entirely appropriate for progress in attaining maximum employment to take center stage in determining the Committee's policy stance", and "I am persuaded, however, by the arguments laid out by our panelist Michael Woodford and others suggesting that the policy rate should, under present conditions, be held 'lower for longer' than conventional policy rules imply."

What does this all imply? I'd say March 2014 tapering, to keep the hawks happy; accompanied by enhanced forward guidance for the doves. Equity markets higher by then on this extended accommodation. 10-year yields falling on weaker data after Washington reaches a compromise, then rising after Q1 2014 as the economy finds its feet again.