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Articles by Matt "NewstraderFX" Carniol

November 19th, 2010 @ 1:27 pm by Matt "NewstraderFX" Carniol

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What I wanted to say in the title was “The Party of No,” as the Republicans have come to be known, by using the Chinese symbol for “no” (which I could not do because the editor doesn’t allow Chinese symbols).

Because of their intense, anti-Obama obsession, Republicans and the Tea Party (which is led by Sara Palin) are now on the side of China as far as U.S. monetary policy is concerned. Talk about politics making strange bedfellows!

Why? Well, if a policy has anything to do with President Obama, the Republicans are reflexively against it even if, as in the case with China and QE2, being against that policy aligns the Rabid Right with the wants and desires of our economic opponents.

What this means is that, in essence, Republicans and the Tea Party are allied with the world’s biggest currency manipulator simply because it suits their anti-government, anti-Obama, and anti-everything agenda.

In any event, the thought of Sara Palin making recommendations on monetary policy is truly frightening, at least to me. And since she is one of the likely presidential candidates in 2012, her amateurish meddling bodes poorly for the idea of a politically independent Federal Reserve, should she indeed manage win office.

The idea of QE2 being some kind of radical policy is grossly misplaced to begin with. The Fed is always in the business of either creating or destroying money, depending on whether it needs to loosen or tighten policy, which it does by either buying or selling T-bills. The main difference with QE2 is that policy is being implemented via longer term Treasury obligations, which are the only instruments available to use since nominal short term rates are up against the zero bound. Additionally, the Fed should have little if any problem tightening policy if and when the time comes because Treasuries are so liquid.

Curiously, economist John Taylor, he of the Taylor Rule, is also against what the Fed is doing even though his rule is currently saying that policy should be more loose than it currently is, even with the full $600 billion of QE2 applied (if you accept William Dudley’s assessment that QE2 is equivalent to between 50 and 75 basis points of easing).

The Taylor Rule is a mathematical formula that forecasts the target federal funds rate using the current annualized inflation rate and the difference between the current unemployment rate and the Non-Accelerating Inflation Rate of Unemployment (usually estimated at between 5.5% and 6%). According to the Taylor Rule, spikes in unemployment above the natural rate call for lower interest rates, especially when inflation is subdued.

Christopher L. Foote, an advisor to the Boston Fed’s Center for Behavioral Economics and Decision Making, said on Sep. 10 that interest rates should stay low for the foreseeable future, and the Fed’s use of non-standard monetary policy to bolster liquidity will likely continue.

According to Foote, the Taylor Rule is saying that the target federal funds rate should be in the range of negative 3.5% to negative 4.5%. And since the federal funds rate cannot fall below zero, Foote said, the Federal Reserve will probably continue to employ unconventional monetary policies to encourage bank lending and increase the money supply beyond what its normal toolkit would allow, which is now what it is doing.

As Foote noted, the Taylor Rule’s forecasts have correlated closely with the actual target federal funds rate over the past decade (see Figure 1), even though the Fed does not explicitly follow the rule.

Here then is a crude estimate of where policy currently is, taking into account the $1.7 trillion of QE1 and the full $600 billion of QE2, using Dudley’s estimate of 50 to 75 basis points for each $600 billion of quantitative easing:

The $1.7 trillion from QE1 represents about 142 to 212 basis points (1.42% to 2.12%) of easing and QE2 adds another 50 to 75 basis points (0.5% to 0.75%). That brings the total amount of interest rate reduction for QE1 + QE2 to between 192 and 287 basis points, meaning that the nominal target rate has been lowered to the equivalent of between negative 1.92% and negative 2.87% which, according to the Taylor Rule, is still too restrictive. So, despite the fact that Taylor’s own rule indicates that the Fed should be doing even more, he’s come out against further quantitative easing!

What’s interesting about the above chart is that it indicates Fed policy was too loose during the 2003 to 2007 period, when the housing bubble was being created.

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November 18th, 2010 @ 11:45 am by Matt "NewstraderFX" Carniol

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As veterans of the financial crisis wars in the Great Repression, the Irish version of “take the EU/IMF money and run” just doesn’t have the same panicky feel as the Greek April-May tragedy.

In other words, Ireland seems to have somewhat of a “been there, done that” feel in that the situation doesn’t seem like an out of control lurch into the depths. S&P futures were rising 12 points heading into Thursday’s NY session and the dollar resumed declining against the euro, pound and Australian dollar.

This time, there just doesn’t seem to be concerns that the single currency is in imminent risk of collapse as there was back in the Spring, on the belief that the European Union will do whatever it takes to keep the currency together, as it has done it before.

The charts seem to bear this idea out; EUR/USD has found support after making a neat little 50% retracement of the upswing against the dollar which resulted in no small part from speculation regarding QE2. It’s also gained against the Australian dollar, Canadian dollar, and even the Brazilian real.

According the Bloomberg, Irish central bank Governor Patrick Honohan on Thursday said he expects the country to ask for a bailout from the European Union and the International Monetary Fund worth “tens of billions” of euros to rescue its battered banks and probably pay an interest rate close to 5%.

“It is my expectation that will happen, absolutely,” said Honohan.

Irish bonds rose after the remarks, according to the article, pushing the yield on the country’s 10-year debt down 10 basis points to 8.22 percent as of 9:43 a.m. in Dublin. The spread over benchmark German bunds narrowed to 537 basis points from 554 basis points Wednesday after hitting a record 652 basis points on Nov. 11.

Also helping markets early Thursday was the successful (7 to 1 oversubscribed) initial public offering of General Motor’s stock, one of the biggest in history.

Still, there’s scope to see concerns over Greece resurface.

Bloomberg reported on Thursday that Greece may raise its deficit forecast during the day when the government outlines plans for the 2011 budget, therefore failing to meet the terms of the 110 billion-euro bailout that saved it from default earlier this year.

It seems as if Greece will not be able to meet its revenue forecasts, which means that it won’t be able to reduce its budget gap to 7% of GDP from 9.4%.

Austria threatened on Nov. 16 to withhold its contribution to the bailout, and Greek 2-year government bonds rose 70 basis points to 11.96% before falling 50 basis points on Thursday.

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November 16th, 2010 @ 11:55 am by Matt "NewstraderFX" Carniol

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I wrote an article back on Nov. 5 entitled “Bearish Divergence All Over The Place” that predicted a come-back for the dollar and at this point, it looks as if the retrace of the move which began on Sep. 9 has some room to run as traders reverse their bets against the dollar. The subject was also covered in my Nov. 1 article (The Dollar Should Gain After The Fed).

Data from the Chicago Mercantile Exchange (CME) show that while traders reduced their extreme dollar short positions slightly after QE2 was announced on Nov. 3, they are still holding shorts at near-record levels. But with Treasury yields now rising rather than falling, the risk of sovereign defaults in Europe increasing, and with euro-zone growth about to falter, support for the dollar is likely to increase as the huge number of short positions is covered.

First, Treasury yields are rising as traders get out of bonds on the fear of Fed-induced inflation, something I covered in another article (The Fed’s Radical Shift). Next, economic data coming out of the U.S. since the Fed’s announcement has greatly improved and if Monday’s report on retail sales is any indication, things are likely to gain momentum heading into the end of the year. Third, the rise in bond yields will make the dollar even more attractive in an uncertain world where investors continue to look for higher but safe returns, especially after data from Europe over the last several weeks has shown that growth in both Germany and France is slowing down rapidly.

In other words, all that talk that the ECB will be able to remain hawkish while the Fed resorts to more easing looks a little premature. The ECB could now well find itself considering further measures to ease credit conditions as the central bank has already been forced to provide European banks with much more short-term funding than expected in recent weeks.

In looking at a chart of the euro, I’ve placed a fib study which covers the euro’s latest run and indicated the previously-mentioned bearish divergence. The short trade was entered in my Trade Room as a pending order which was issued at the close of trading on the 15th based upon one of my main goals in trading: sell high (if possible) which means in this case that I was looking for a move up to the 38.2 fib level, where resistance was likely to be found.

The target for this trade is down near the 61.8 fib level because I’m looking for something I’ve frequently seen to repeat; whether the retrace I am looking at is up or down, once price closes past the 38.2, it is very common to see it eventually move to the 61.8. It also is very possible to see to see the 38.2 tested as resistance again over the next few days.

A more conservative target would be to the 50% level and indeed, I’ll look to reassess this trade should the euro move there.

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November 12th, 2010 @ 4:17 am by Matt "NewstraderFX" Carniol

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In the first installment of this article, I wrote about bearish divergence on the EUR/USD and AUD/USD  pairs and provided a couple of charts. I also mentioned that a bearish divergence existed on gold, while a bullish divergence was seen on the chart of USD/JPY.

In my trade room, we’ve just taken a long in this pair based purely on the following technical indicators and price actions:

1.       Where price sits in relation to a fib study I have

2.       The way  price has moved in the first few hours of Friday’s trading

3.       The bullish divergence

4.       The Deliman indicator

For those of you unfamiliar with the term, “deliman” refers to the person who works behind the counter at a delicatessen slicing cold cuts and making sandwiches. And as much as I enjoy talking sports with my favorite deli man, an area in which he displays quite an expertise, when it comes to forex trading let’s just say that he wouldn’t know the difference between the ECB and the planet Krypton. And yet, like pretty much everyone else these days, he’s very concerned about the dollar’s decline and is “pretty sure” that it’s about to depreciate into oblivion. For goodness sakes, he’s even become familiar with the term “quantities easing,” and is now very nervous about the government’s plan to “crank up the printing presses!”

Not that I mean to sound like some kind of currency snob, but when people who hadn’t heard of the Federal Reserve until last week start telling me their opinion on currency movement, that’s pretty much all I need to hear in order to make a decision to get out of the previous trend. In other words, the “Deliman indicator” is one of the best contrarian signals known to man.

As far as the other factors in this trade are concerned, as you can see on the chart, Thursday’s trade closed above the 14.6 fib line, which I take as a sign the nascent bullish trend on the pair will continue. What’s also happen is that early in Friday’s trade, price has retraced 61.8% (in pips) of  Thursdays range, which was to 82.25, and has found support there (Friday’s low, to this point was 82.22). The bullish divergence was made 9 days ago when price made a lower low and the MACD made a higher low.

The stop is about 10 pips below Friday’s low and the target is just below the 23.6 fib level, which gives this trade a nice little 5:1 reward to risk ratio. Actually, there’s no reason not to think we can’t get to the 38.2 eventually, but there should be another chance to get in later.

*Extra Credit:

Check out how the day the BOJ intervened turned out to match up with the 38.2 retrace level.

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November 10th, 2010 @ 5:53 am by Matt "NewstraderFX" Carniol

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There is a world of turmoil heading into this week’s meeting of the G-20, and the situation looks to get worse going forward as major exporters such as Germany, Brazil and China lash out at the Federal Reserve’s plan (dubbed QE2) to purchase an additional $600 billion of U.S. debt.

But the award for having the most unmitigated gall has to go to Chinese rating agency Dagong Global Credit Rating Co., which downgraded the long term sovereign credit rating of the U.S. based in part on what it sees as the “drastic decline of the government’s intention of debt repayment.”

Dagong warned that “serious defects in the United States economic development and management model will lead to the long-term recession of its national economy,” as the “new round of quantitative easing monetary policy adopted by the Federal Reserve has brought about an obvious trend of depreciation of the U.S. dollar.”

As a result of additional Quantitative Easing, the agency warned that, “an overall crisis might be triggered by the U.S. government’s policy to continuously depreciate the U.S. dollar against the will of creditors.”

In other words, the rating agency, and by extension Chinese authorities, are now of the opinion that the monetary policies of the United States should first be vetted and approved of by Beijing.

Predicting unequivocally that “the U.S. economy will be in a long-term recession,” Dagong believes that “the trend of the U.S. dollar depreciation will cripple the value transfer capability of the financial system to attract dollar capital reflow.”

In other words, Dagong is saying that there will be a severe shortage of buyers for U.S. debt in the not too distant future.

The agency summed up its outlook on the U.S. as follows:

“Dagong believes that the occurrence and development process of the credit crisis in the U.S. resulted from the long-standing accumulation of the contradictions in its economic system; the U.S. debt burden can be relieved only to a certain extent through large-scale printing and issuance of the U.S. dollar; however the consequent decline of the U.S. dollar status and national credit will block the debt revenue channel which is vital to the existence of the United States to a greater extent. The potential overall crisis in the world resulting from the U.S. dollar depreciation will increase the uncertainty of the U.S. economic recovery. Under the circumstances that none of the economic factors influencing the U.S. economy has turned better explicitly it is possible that the U.S. will continue to expand the use of its loose monetary policy, damaging the interests the creditors. Therefore, given the current situation, the United States may face much unpredictable risks in solvency in the coming one to two years. Accordingly, Dagong assigns negative outlook on both local and foreign currency sovereign credit ratings of the United States.”

In response to QE2, China has already begun implementing controls on capital inflows, and Chinese central bank adviser Xia Bin said the nation should tax inflows of short-term capital and send a clear signal that speculators bringing hot money into the country will be punished.

In an effort to window-dress, China allowed the yuan to rise to the highest level against the dollar since 1993 ahead of the G-20 meeting this week, after posting a larger-than-forecast $27.1 billion October trade surplus.

Bloomberg is reporting that South Korea may revive a 14% tax on domestic Treasury and central bank bonds held by foreigners as early as January to curb foreign-exchange volatility, a ruling party lawmaker said.

“If we don’t do it right now and the situation worsens, we may have to set up higher barricades,” Kim Song Sik, a member of the Grand National Party and the legislature’s financial committee, said in an interview yesterday in Seoul.

South Korea’s won has advanced more than 9% against the dollar since June, the second-best performer in Asia outside Japan, after Thailand’s baht.

The World Bank said yesterday that Asian economies may need capital controls as U.S. quantitative easing threatens to stoke asset bubbles in their stock, currency and property markets. Taiwan yesterday said it will restore curbs on foreign investment in its debt, only allowing offshore funds to have as much as 30% of their portfolios invested in all types of government bonds and money-market products.

From here, it looks like the Currency War is on. And as far as my reaction to Dagong is concerned, allow me to echo the words of General Macauliffe of the 101st airborn division on receiving a German surrender demand during WWII: “Nuts!”

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November 7th, 2010 @ 4:10 pm by Matt "NewstraderFX" Carniol

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QE2, the Federal Reserve’s program to buy an additional $600 billion of Treasuries (along with an estimated $200 to $300 billion in re-investment of maturing securities), should be far more effective than QE1 because this latest installment of Quantitative Easing will ultimately create what the original program did not: velocity of money.

With QE1, the Fed’s newly printed dollars were used (for the most part) to purchase illiquid assets such as mortgage backed securities from the large commercial banks. Whether by choice or not, the cash received for these securities is being held on deposit at the Federal Reserve Banks (i.e. the Fed bought assets from the large commercial lenders who are just keeping that cash at the Fed).

You can see this by looking at the Fed’s balance sheet (the weekly H.4.1 report). As of November 4, term and other deposits held by depository institutions at all Federal Reserve Banks was still nearly $988 billion, down just $77.3 billion from one year ago. In normal times, this number varies between $8 and $14 billion or so.

We can speculate on the reasons why the large lenders are keeping their powder dry at the Fed. For one thing, the banks are still reluctant to lend. Also, the deposits are receiving 0.25% interest. Another possibility might have to do with the ultimate disposition of all this paper; while not repo agreements, the Fed likely does not envision holding these assets to maturity (and it may want to sell them relatively quickly if and when the need comes to tighten policy), which means that the door to the banks buying these assets back is probably still open, especially since the cash to do so is readily available.

What all of this means, however, is that in essence, QE1 created very little velocity of money because the cash created in the first program is not moving through the system. For whatever reason, a large percentage of QE1 cash is doing nothing more than sitting at the Fed collecting 0.25%.

With QE2, the Fed is not buying an illiquid asset from a bank; what they are buying is an extremely liquid asset from its dealers, and they are doing so with newly created money. The fact that Treasuries are totally liquid means that the Fed’s new QE2 money will circulate into the system and do a far better job at creating money velocity than the cash used for QE1 as long as the following condition is met (which it will be):

To simplify things, let’s say we have 2 bidders at a Treasury auction, each with $100 billion to spend. Along comes the Fed with $100 billion that it just printed and buys all the Treasuries at that particular auction. The 2 bidders that got shut out are not going to keep that cash in their pockets; it is a virtual certainty that they are going to buy something else, especially because speculation is rampant that the dollar is going to be depreciating due to the Fed’s actions. So, what these bidders will do is buy Treasuries in the secondary market, if that’s what they want. They can also buy stocks, which is what I am sure the Fed is hoping they will do. They can get into commodities and help to create some inflation (which is also what the Fed wants). Or gold. Or whatever they want.

So now, you have $100 billion x 3 in the system, not $100 billion x 2, because the Fed’s money is newly printed money and because the 2 buyers that were shut out at the auction will not be staying in cash. But what is essential is that the dealers who sold the Fed its Treasuries have no reason to hold that money at the Federal Reserve Banks (as the large depositories are doing), because they have no need to hold reserves.

In other words, the Fed will not need its dealers to hold cash because when the time comes to tighten policy (selling Treasuires back to its dealers in order to drain cash from the system), the dealers will be able to buy whatever amount the Fed requires them to as the secondary market into which they can off-load their inventory is extremely deep and liquid (unlike the market for mortgage backed securities).

So, it is likely that dealers are going to do what dealers do-circulate the money received from the Fed, money that otherwise would not have been there because it is newly created, thereby generating what QE1 did not: velocity of money. But that is not all.

The Zero Hedge blog came to an interesting conclusion vis a vis what the Fed’s primary dealers do with the cash by analyzing the Permanent Open Market Operations of the Federal Reserve Board of New York.

According to ZH:

The same primary dealers who were the benefactors of the Fed’s guaranteed UST bid instead used the end of quarter, FRBNY-facilitated window dressing to not only not offload coupons, but to dump everything else, and use the proceeds to buy stocks thereby explaining both the massive ramp into the end of September, and also the ongoing attempt to flush NYSE shorts.

Now, how much of an effect this will ultimately have on the real economy is certainly open to debate (in nominal terms, if the Fed gets to $900 billion by June 2011, it will have added 6.11% in cash relative to 3rd quarter 2010 GDP). It could very well turn out that, much as the stimulus, the initial $900 billion of new purchases and rollovers will be too small to have the desired effect. But the FOMC has left the door open to doing more and with Mr. Bernanke at the helm, there should be little doubt that additional Quantitative Easing will occur should conditions warrant.

Currently, I believe we will see the weak dollar trend retrace to a degree over the next few days and weeks but it is my opinion that over time, what we can expect to see is the economy growing faster than it otherwise would have, which means that stocks and commodities should continue to do well as the dollar depreciates.

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November 5th, 2010 @ 2:11 pm by Matt "NewstraderFX" Carniol

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To be honest, there aren’t very many technical indicators that peak my interest, being that I believe it’s the fundamentals that get markets moving in a trend. There is one, however, that I do pay attention to, especially if I can find a historical precedent.

The indicator I use is the MACD but I only look for times when divergence, either bullish or bearish, is present on the daily charts. And right now, bearish divergence is there on EUR/USD, AUD/USD and GOLD, while bullish divergence is showing up on USD/JPY.

For a quick review, bullish divergence is seen when price makes a lower low while the MACD makes a higher low. Bearish divergence occurs when price makes a higher high while the MACD makes a lower high.

Admittedly, it’s hard to think about getting long the dollar after the Fed announces an additional $600 billion on new Treasury purchases. But if the dollar does gain some ground in the next few days and weeks, it would only be repeating a pattern that’s already happened fairly recently in a very similar circumstance.

The last time the Fed announced a round of Quantitative Easing was back on March 18, 2009. The euro popped that day and the next. But afterwards, it basically floated along for several days before plunging about 700 pips off its peak.

There’s another indicator I use which tells me a trend is getting old, one I call it the “Grandma Indicator.” The way this works is very simple.

My dear Grandma, much as I love her, is not exactly current on all the machinations of the Federal Reserve (although she’s pretty sure that “those bastards” at the big banks should be strung up for helping to create the biggest financial disaster since the Great Depression). However, even Grandma has heard that the Fed is printing more dollars. So, when Grandma starts asking me about “buying some gold,”  I start thinking “wow, this trade is really getting long in the tooth.”

But it isn’t just Grandma. The guy at the deli who makes my 4 egg whites sandwich in the morning is now feeling “pretty sure” that the dollar is going to weaken some more. Can anyone say “contrarian indicator”?

Now, I’m not saying that the dollar is going to gain for weeks on end; what I am suggesting is that the short dollar trend is going to retrace before resuming. Over the medium term, the dollar is bound to fall further (absent a threat of systemic risk such as the European Sovereign Debt Crisis) while stocks gain because as I will point out in my next article, QE2 is likely to be far more effective than was QE1 in creating money velocity.

How much will the dollar gain during this retrace? For that answer, I invite you to join my trade room.

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November 4th, 2010 @ 10:07 am by Matt "NewstraderFX" Carniol

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The last time the Fed announced a large expansion of its balance sheet, back on March 18, 2009, the euro peaked over several days and then declined about 700 pips before going on a run which would last until investors first became nervous about Greece in December.

I’ve been thinking for a while about why this happened, because we’ve known for a long time that Bernanke was intent on printing yet more dollars. Could it have been that investors just did not understand well enough what Quantitative Easing was back then, or was it just a case of banks and other dealers wiping out the stops of every retail trader on earth who bet the dollar would weaken as a consequence of an ever-increasing supply?

As of Thursday morning in NY, the dollar had declined against all comers, just as it did after the Fed’s last injection of liquidity…anyone tempted to bet that history will repeat itself?

In any event, I’m not so sure that QE2 is really capable of doing much for job creation in the U.S. because what the program really means is that the Fed will be acting as more of a substitute buyer who happens to be printing its own dollars rather than the buyer of last resort (the way it was previously), injecting new dollars into the system when no one else would. I’ll explain.

Before, the Fed concentrated most of its purchases on illiquid assets-all those mortgage backed securities which no one wanted to buy that were sitting on the banks’ books collecting little more than dust. Trading its freshly minted electronic dollars for these assets unquestionably provided cash for the system that otherwise would not have been there.

The Treasury market, however, is a completely different animal because these securities are anything but illiquid. In other words, if the Fed was not doing the purchasing of what will almost be the entire issuance of new U.S. government debt, there would be plenty of other suitors available. Mr. Bernanke is not acting as a buyer of last resort now, he is simply trying to crowd out other buyers and create more competition amongst potential bidders at the government’s Treasury auctions in an effort to raise prices and lower interest rates.

Still, absent the flair-up of a sovereign debt crisis (or some other huge risk to stability), the dollar is likely to weaken over the medium term, which means that Mr. Bernanke will have his inflation. And for anyone who is not in a position to increase their nominal income, well, they can expect to see their ability to buy the things that they want, as opposed to those they need (such as food and fuel) diminish. In other words, things are about to get worse for the average citizen because the Fed will do nothing about the inflation to come until it overshoots by a good amount.

In any event, things will most likely feel worse for most people well into 2011 because year-over-year GDP is about to take a dive.

When you look at Q2 2010 compared to Q2 2009, the economy grew a healthy 3%, and that number improved to 3.11% when comparing third quarter yoy results. But if the economy, as many are predicting, continues along this path, growing 0.5% per quarter as it did in the last GDP report, yoy growth will decline to 2.36% in Q4 and to 1.93% in Q1 2011.

Such growth, though not officially, means that for all intents and purposes there will likely be a two quarter slowdown that will feel like a recession to many, which is pretty much what economists such as Nouriel Roubini have been predicting for quite some time.  And with the new Republican majority in the House of Representatives, it is guaranteed that no new stimulus of any kind will be coming from fiscal authorities. In fact, if the newly elected politicians have their way, the government will be cutting back on its expenditures.

So, the bottom line is that the Fed is left on its own to do the heavy lifting with a plan that is bound to be less effective, which means we all better hope that Washington finds a way to extend the Bush tax cuts, the only form of new stimulus left open.

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