–QE3 Necessary to Keep FOMC Ahead of the Curve
–Better U.S. Jobs Picture Not Going to Help Consumer Spending

By Denny Gulino

WASHINGTON (MNI) – Once seen as a minor influence on the U.S.
economy, Europe is now governing U.S. interest rates and economic
prospects, forcing the Fed to go ahead with QE3 to stay ahead of the
deteriorating economic picture, the lead economist on the SIFMA outlook
panel said Tuesday.

In a conference call with a few reporters, Wells Fargo Chief
Economist John Silvia, speaking for the 20 well-known economists on the
SIFMA panel, said more important than their specific economic
assumptions is the panel’s framework for assessing the likely key
downside risks. The two most important? Europe and U.S. fiscal chaos.

The FOMC is seeing that Europe has been the downward influence on
interest rates, he said. And even an improving U.S. jobs picture won’t
overcome the anxiety of consumers about possible higher taxes among the
“vast majority” of consumers who already have jobs.

The FOMC, now in the first day of its two-day meeting, will have to
implement some kind of QE3 Wednesday or risk being behind the curve when
the next jobs report comes out, Silvia said.

“Europe has been the surprise,” he said. “Compared to two years
ago, Europe has had a much greater impact on the overall U.S. outlook,”
Silvia said. “People were writing a year or two ago, well, you know,
Greece is less than 1% of U.S. trade, Europe is 15% of U.S. trade —
it’s going to have a negative impact, but pretty small.”

“The financial links were totally ignored,” he continued. “It was
the withdrawing of liquidity” and “capital flight” that held sway. “Look
at the Swiss National Bank, how much intervention they’ve done, and now
they have negative interest rates” along with Denmark. “The short-term
interest rates in Germany are negative and you’ve seen than capital
flight show up in the U.S. dollar.”

“Europe has had a fairly pervasive impact,” Silvia said. “It’s made
the dollar a little bit stronger, it’s made our interest rates as little
bit lower,” and even forced “lower gasoline prices overall.”

Capital spending has slowed down and the survey of economists has
shown the Europe’s impact.

“The Fed has to make a decision today and tomorrow,” he said, “and
the employment release comes out the first of July. If the Fed appears
to take a very timid approach and then the July number on employment is
very negative, it’s going to immediately look like the Fed’s behind the
curve.”

With 65% of the SIFMA panel seeing the Fed choosing to implement a
third round of quantitative easing at this meeting, “I think this is
telling me, let’s get ahead of the curve.”

Right now, “the lack of a good credit channel,” he said, “is
hampering economic growth” and “it limits, I think, the ability of the
Fed to move the economy forward.”

“In practical terms, it means that actions like QE3 and QE2 for
that matter” have a “reduced impact over time. The economy is faced with
“new regulations, uncertain collateral, limits in terms of capital
standards, people very uncertain about what the environment will be in
six months or nine months.” In fact, no one knows the sustainable rate
of housing starts.

“Fed, you can go out there and buy mortgage-backed securities, you
can go out and buy the Treasuries, do QE3, but I’m not sure how much
change we’re going to get in housing until people figure what’s the real
value of this house,” Silvia said.

“Allocating credit in a modern American society is a challenging
business,” he said.

The SIFMA panel sees the U.S. economy growing at 2.1% in full-year
2012 and to grow at a rate of 2.1% in 2013. That is slightly weaker than
the same panel saw at the end of last year.

The panel saw unemployment remaining at elevated levels throughout
2012 and 2013, with the full-year average unemployment rate dropping
only slightly to 8.1% this year and then declining to 7.8% in 2013.

The median forecast for “headline” inflation, measured by the
personal consumption expenditures chain price index, was 1.8% percent
for full-year 2012 and 1.7% for full-year 2013.

Approximately 70% of survey respondents expected the Fed
Funds-to-10-year Treasury yield curve to steepen over the remainder of
2012, while 60% expected the future path of the TED (Treasury bill less
LIBOR) spread to remain unchanged. Opinions were also split on the path
of investment-grade spreads, with half of respondents expecting the
spread to narrow, while the other half expected the spread to remain the
same.

Panelists placed approximately a 70% chance on WTI oil prices
remaining below $100 per barrel in 2012, with a 25% chance of prices
moving into the $101 and $150 range and only a 5% chance for oil prices
moving above $150 per barrel.

** MNI Washington Bureau: 202-371-2121 **

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