Fed vs Obama: Tax deal drives up rates

The Pak Banker - - International3 -

WASHINGTON: What the Fed­eral Re­serve giveth, Obama taketh away. The U.S. cen­tral bank's $600 bil­lion stim­u­lus plan was sup­posed to lower in­ter­est rates. But Pres­i­dent Barack Obama's tax deal with Repub­li­cans, by rekin­dling fears of bud­get deficits in the bond mar­ket, has pushed them higher.

As the Fed meets this com­ing week, the sur­prise shot in the arm from the fis­cal au­thor­i­ties might strengthen the case of hawks at the cen­tral bank, who think the econ­omy is al­ready grow­ing of its own mo­men­tum. They could ar­gue to scale down the $600 bil­lion in bond pur­chases an­nounced in Novem­ber.

"The shift to fis­cal stim­u­lus im­plies that of­fi­cials would be less in­clined to ex­tend the cur­rent pro­gram be­yond the sec­ond quar­ter of 2011," said Richard Berner, an econ­o­mist at Mor­gan Stan­ley.

On Wall Street, econ­o­mists are busy re­vis­ing up their fore­casts for U.S. eco­nomic growth in 2011, in part be­cause the tax deal will of­fer more short-term stim­u­lus than many ex­pected.

The pack­age, which still needs con­gres­sional ap­proval, ex­tends the Bush-era in­come tax cuts, low­ers pay­roll taxes by 2 per­cent­age points and pro­vides ad­di­tional job­less ben­e­fits. But it is un­clear how much these new Wall Street eco­nomic pro­jec­tions fac­tor in the re­newed deficit fears that drove yields on bench­mark 10year notes to a six-month high last week. That's a ques­tion Fed of­fi­cials will pon­der when they meet on Tues­day.

Moody's In­vestors Ser­vice said it is wor­ried the pro­posed tax re­duc­tions could be­come per­ma­nent when many of them come up for re­view in the pres­i­den­tial elec­tion year of 2012, hurt­ing U.S. fi­nances and credit rat­ings in the long run. With Europe's cri­sis putting debt wor­ries high on in­vestors' minds, it is lit­tle sur­prise bond traders grew jit­tery at the prospect of more U.S. govern­ment debt.

The tax deal an­nounce­ment came swiftly on the heels of a pro­posal from Obama's deficit-re­duc­tion com­mis­sion that failed to win enough sup­port to force leg­isla­tive ac­tion.

"Yields are up ... be­cause we got $1 tril­lion in deficit spend­ing with no signs of fis­cal dis­ci­pline on the hori­zon," said Ju­lia Coron­ado, econ­o­mist at BNP Paribas in New York.

"It feels to global in­vestors like the U.S. is be­com­ing Ar­gentina," she said. "The back up in bond yield will rob much of the pos­i­tive im­pact of the stim­u­lus."

With the U.S. hous­ing sec­tor still mired in a pro­longed rut, higher rates are cer­tain to do more dam­age, cur­tail­ing re­fi­nanc­ing ac­tiv­ity and wors­en­ing a log­jam in fore­clo­sures linked to faulty doc­u­men­ta­tion.

Against that back­drop, it is some­what baf­fling to see fore­cast­ers fran­ti­cally rais­ing pro­jec­tions for eco­nomic growth. Berner at Mor­gan Stan­ley says the tax agree­ment could push growth up by as much 1.2 per­cent­age points in 2011, putting it above 4 per­cent.

Given those pro­jec­tions, the bond sell off could sim­ply sig­nal ex­pec­ta­tions of stronger growth. A more ro­bust U.S. econ­omy would be par­tic­u­larly wel­come for the global econ­omy at a time Euro­pean na­tions are putting in place aus­ter­ity bud­gets to deal with their debt trou­bles. -Reuters

MUS­CAT: Hyukjin Kwon of South Korea and Mohd Shukri Jaineh of Brunei com­pete Men's Beach Sep­a­k­takraw Regu Pre­lim­i­nary Pool Match be­tween South Korea and Brunei at Al-Mu­san­nah Sports City dur­ing day six of the 2nd Asian Beach Games Mus­cat 2010 on Mon­day. -Reuters

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