RDQ weekly economic update

Our long-held forecast was that the Fed would not take the first step to hike rates before March 2011 at the earliest. This was once a controversial forecast but it is now market consensus. With March 2011 only eight months away, it is time to sharpen our views on the Fed.

The recent softer economic data and debt contagion fears from Europe have likely hit policymakers confidence in the economic outlook. Some Fed officials are talking about the possible need to further ease policy (but any such action would face a high bar).

While we do not see further easing, we now believe that the earliest the Fed will hike rates is September 2011. From the Fed’s perspective, labor market slack, inflation trends, and inflation expectations all point to a prolonged period of policy remaining on hold.

We do not believe that the likely path for monetary policy is the optimal path. Gold is uncomfortably high and signaling growing distrust of paper money. Inflation in China is rising and China has played an important role in masking inflationary pressures in the U.S.
Recent market moves have given investors the opportunity to reduce their holdings of Treasuries and buy hard assets and equities. We think this is the right trade and it is consistent with our investment themes for 2010.

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