ECONOMETER

President Obama, the Fed’s Beige Book and a firm reading for US retail sales provided some temporary relief for the beleaguered USD but this soon gave way to renewed pressure. Obama proposed cutting around $4 trillion from the fiscal deficit over the next 12-years, similar in size to Republican plans, but structured differently. Separately the Beige Book relatively upbeat, noting “widespread” economic gains across sectors. Finally, whilst top line retail sales were slightly softer than forecast ex-autos sales were upbeat, with upward revisions to the past month.

President Obama’s deficit reduction plans sets the stage for a fractious political battle regarding the $14.3 trillion debt ceiling. Having averted a government shut down following a late agreement between Republicans and Democrats the USD will have a much bigger challenge to face in the weeks ahead. Obama has stated his support for raising the debt ceiling but if agreement is not reached by around mid May (or July if temporary measures are introduced), the US government may effectively default.

When will the USD lose its funding currency mantle? The approach of the end of quantitative easing (QE2) by end June 2011 (assuming the Fed sticks to the plan) will be a particularly important period for the USD. Assuming that there will be no QE3 much will depend on how proactive the Fed is in reducing the size of its balance sheet. This remains unclear and judging by the variety of comments from Fed officials over recent weeks, there is plenty of debate within the Fed FOMC about the pace of balance sheet reduction.

St Louis Fed President Bullard (non-voter) maintained his hawkish stance by highlighting his preference for reducing the Fed’s balance sheet rather than hiking interest rates as a first step towards policy normalisation. There will be further clues both in terms of Fed thinking as well as inflation pressures.

Fed speakers including Duke, Kocherlakota and Liang, Plosser, Tarullo, Lacker, Baxter and Evans will give further clues. CPI inflation data will also be in focus, with headline inflation likely to be boosted by higher energy prices but core inflation likely to remain well behaved. Despite Bullard’s comments the majority of Fed officials appear to be taking a more cautious stance, suggesting that the USD will remain under pressure for a while yet.

The EUR continues to capitalise on generally weak USD sentiment despite nervousness about the details of Portugal’s bailout program. More worryingly for the EUR is ongoing speculation about Greek debt restructuring, with S&P ratings agency noting that the risk of Greek debt restructuring was almost one in three and the Zeit newspaper reporting that investors could lose around 50-70% in a restructuring. Although plans to restructure have been denied by the Greek government this has not stopped Greek bond yields from skyrocketing.