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What to expect from the Fed: Bupkis, with a dash of gloom

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Markets await Fed Today's meeting of the Federal Reserve had already been shaping as a key one. Now, given the volatility in markets, the policy announcement this afternoon has heightened expectations.

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The U.S. central bank won't tinker with interest rates, of course, but investors are watching for signs that the Fed may be poised for other forms of stimulus, such as a third round of quantitative easing. Economists don't expect the Fed to announce further QE, as it's known, a bond-buying program to drive down longer-term rates, but investors will be eagerly awaiting the announcement.

"Some market participants will be looking to gauge whether the Fed will give any clues as to the timing of a possible QE3, given the massive falls in equity markets in recent days, however it could well be the only thing the Fed are likely to do is downgrade their growth forecasts for the U.S. economy, while reiterating their intention to keep rates low for an extended period, given that their monetary policy toolbox is starting to look a little depleted," said CMC Markets analyst Michael Hewson.

Camilla Sutton, the chief currency strategist at Scotia Capital, expects the Federal Open Market Committee, the central bank's policy-setting panel, will disappoint investors with a "dovish" statement.

"Markets are undergoing a crisis of confidence built on investor realization that the solution is not an easy one and that there is likely little the Fed can do to stem losses," she said. "Growth is lower than expected, the U.S. is in the midst of a fiscal crisis with little political will to solve it, while Europe has a fiscal and debt crisis and a central bank that has likely made a policy mistake by raising interest rates."

There are four "obvious policy tools" the Fed can use, though she doesn't expect any to be unveiled this afternoon:

  • Further quantitative easing, or QE3. "Without the threat of deflation and with mixed reviews as to the success of QE2, we do not think the Fed will opt to announce yet another round of asset purchases."
  • Changing the wording of its statement to include a timeline for low rates, but that's "a policy tool that would do absolutely nothing to stabilize confidence."
  • Lowering rates that the Fed pays banks for what they hold in reserve, also a measure that would have effect.
  • "Operation twist," a move to bring down longer-term rates without impacting those of shorter terms, as was done in the 1960s in a bid to block the flow of gold out of the United States and support the greenback. "Again we see little value in such a strategy in the current environment as the problem isn’t rising long-term yields or flows into the [U.S. dollar] but instead a collapse in confidence."
  • As RBC strategists Mark Chandler and Ian Pollick, the expectations for today's meeting are high as "markets remain desperate for a lifeline." But they, too, expect no new measures, though the outlook could be downgraded.

"If the Fed were to adopt any new monetary policy measures at today's FOMC meeting beyond simple liquidity efforts, the path of least resistance would seem to be a 'promise' to avoid early exit policies," they said.

ECB buys bonds The European Central Bank confirmed today that it has been buying up euro zone bonds, though it didn't specify which countries. It was widely believed to be buying Italian and Spanish debt to try to stop the debt crisis from spreading further through the 17-member monetary union.

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"We are in the secondary market," ECB chief Jean-Claude Trichet told a radio interviewer.

As The Globe and Mail's Rita Trichur writes today, the central bank is in a particularly tough spot, criticized in some quarters for raising rates in the midst of a crisis as its mandate remains to control inflation. Now, though, the ECB has taken firm steps to fight the debt crisis.

And many observers believe the efforts are only a quick-fix solution, with no lasting impact.

"The ECB stepped in to buy the sovereign debt of Italy and Spain yesterday, with some success," said Carl Weinberg, chief economist at High Frequency Economics.

"Today, the second day of intervention, saw more modest gains in prices. We would be surprised if it had been otherwise, just as we will be surprised if this lasts very long ... If we are right about all of this, the ECB's intervention will fail to convince the markets that the underlying problems in the economies - huge fiscal deficits and a broken banking system in Spain's case - have been addressed. That means access to the markets for these sovereign borrowers will be constrained for some time."

Markets swing Global stock markets are swinging violently this morning, with Asia plunging, Europe all over the map, and U.S. stock futures moving from good to bad to worse and back to good again. As The Globe and Mail's Omar El Akkad reports, volatility rules.

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"Traders are shell-shocked by the recent drops and it remains difficult to see what can be done in the short-term to instil any confidence back into the market," said David Jones, chief market strategist at IG Index. Parallels being drawn with the 2008 financial crisis are starting to look very valid."

Tokyo's benchmark Nikkei shed 1.7 per cent, while Honk Kong's Hang Seng plunged 5.7 per cent. In Europe, stocks were mixed, and in North America, the Dow Jones industrial average , the S&P 500 , and the S&P/TSX composite index all climbed.

Dollar temporarily below parity The Canadian dollar dipped briefly below parity today as the chaos in global financial markets continued, but then picked up steam again.

"Everything is getting smashed," said Elsa Lignos, senior currency strategist at RBC in London.

The loonie has now lost about 6 cents since its most recent high of $1.0631 U.S. on July 26, noted Scotia Capital's Ms. Sutton, adding she expects the volatility in currency markets to continue as investors increasingly fret that the global recovery has stalled out

"I think what we're seeing is a crisis of confidence in markets," Ms. Sutton said.

As The Globe and Mail's Richard Blackwell reports today, investors are searching for havens amid the havoc, and the loonie isn't cutting it any longer, not like Japan's yen or the Swiss franc.

"With sentiment seemingly getting worse by the minute, overnight moves can only be characteriszd as extreme," said RBC's Ms. Lignos. "Markets are taking it in turns to liquidate risk proxies."

The Australian and New Zealand currencies "took the brunt of it in Asia," she added, while the yen and the franc rallied.

Chinese prices climb China's annual inflation rate picked up again in July, inching up to 6.5 per cent from 6.4 per cent a month earlier.

As Carolynne Wheeler reports today from Beijing, food prices were the main culprit, rising 14.8 per ceent on an annual basis. Pork prices, in particular, have shocked buyers, climbing by more than 56 per cent.

China has moved aggressively to keep inflation in check, and many analysts believed it was near its peak. The latest numbers, released with a series of others today, mean Beijing may be loath to jump in with hefty stimulus measures should the global economy slump, said Benjamin Reitzes of BMO Nesbitt Burns.

Still, today's readings suggest China's economy, the engine of global growth, is still strong.

"Markets are acutely concerned about the global economic outlook and the overnight data provided little encouragement," Mr. Reitzes said.

"China's July economic data disappointed. Industrial production rose 14 per cent year over year, retail sales climbed 17.2 per cent year over year, and fixed asset investment was up 25.4 per cent in the first seven months of the year, but all were below expectations and slowed from the prior month," he said in a research note. "Despite the relatively soft data, these figures are still consistent with solid growth in China, and suggest a soft landing scenario remains intact."

U.S. productivity slips Not that you can blame them, but American workers have been somewhat less productive for half a year now, which could pressure employers not to hire.

Productivity in the second quarter slipped 0.3 per cent, the U.S. Labor Department said today, following on the drop of 0.6 per cent in the first quarter. Labour costs, in turn, climbed 2.2 per cent in the the past quarter.

The fall in US non-farm productivity and rise in unit labour costs in the second quarter does not bode well for either corporate profits or the jobs outlook.

"The fall in U.S. non-farm productivity and rise in unit labour costs in the second quarter does not bode well for either corporate profits or the jobs outlook," said Paul Dales, senior U.S. economist at Capital Economics in Toronto.

"The 0.3-per-cent annualized fall in productivity was the second drop in a row (the first quarter's rise was revised to a 0.6-per-cent decline) and was due to output rising at an even more modest rate than employment. This suggests businesses have largely exhausted the efficiency enhancing measures that, even after some large downward revisions to the back data, resulted in impressive average annual productivity growth of 3.3 per cent over the last two years."

Dorel slips Canada's Dorel Industries Inc. says the softening U.S. economy helped push down its second-quarter results.

Dorel's profit slipped to $23-million (U.S.) or 70 cents a share, dilute, from $32.9-million or 99 cents a year earlier. Revenue, though, climbed almost 2 per cent to $619-million.

Its recreational and leisure business performed well, said chief executive officer Martin Schwartz, though its juvenile division was hit. Dorel makes juvenile products and bicycles.

"Costs in the first half of 2011 are higher than last year, and given the highly conservative spending of today's typical consumer, initiating price increases to our customers is a challenge, particularly within our juvenile segment in the U.S.," Mr. Schwartz said.

"While the economic climate in Europe remains difficult, notably in southern Europe, Dorel Europe is protecting or increasing its juvenile products' market share."

Where S&P cut This is, overall, an extremely gloomy business report, so I offer you this: Even the lads who stormed Iwo Jima haven't escaped the attention of Standard & Poor's.

Along with the overall downgrade of America's debt, the credit rating agency also trimmed its measures for several government-related bodies. Among them were the Marine Corps Community Services, also to double-A, the Army and Air Force Exchange Service, and the Navy Exchange Service Command.

These aren't the actual military groups, but rather their support services.

From today's Report on Business

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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