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GRI Weekly Risk Outlook - December 15, 2014
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The US Fed: Enlightened Forward Guidance? 

There is much expectation ahead of the Federal Open Market Committee (FOMC) meeting on Tuesday (16 Dec.) and Wednesday (17 Dec.), which is likely to give a greater insight on the future path of US monetary policy.

The prospect is that the Federal Reserve is likely to move away from its “considerable time” language and shed some light on the eventual timing of a progressive rate hike, most likely in Q3 2015. In the wake of a US hiring surge in November, unemployment and inflation figures have fallen below the Fed’s threshold targets and we therefore deem that the FOMC will start to provide a new form of forward guidance – most likely in the form of language emphasizing that the rate hike is on the cards, just not imminently.

With the significant fall in crude prices and the robust performance of the US economy, the Fed will probably tone down its inflation and unemployment forecasts. If the Fed is to continue shaping policy in a data-dependent manner, we expect Ms. Yellen to provide enlightened forward guidance to markets in the form of a more precise timeline prospectus destined to prepare markets for the unwinding of unconventional monetary policy in the US.

Greece: prospects of political turmoil ahead 

Alluding to mounting pressure on the government to bring forward the date of Greece’s March 2015 general elections, the Greek Prime Minister announced last week that his decision to hold snap presidential elections were prompted by the need to restore political stability.

Shortly after the announcement of this decision, anxiety over the prospects of upcoming political turmoil prompted a 12.8% fall in the Athens stock exchange, the biggest drop recorded since December 1987. This has generated widespread investor concern in regards to the higher likelihood of Greece defaulting on its debt, particularly as short-term borrowing costs have been pushed above their long-term counterparts in the wake of the government’s failure to undertake the required reforms to secure the concluding bailout payment.

With PM Antonis Samaras putting forward Stavros Dimas as his candidate for the presidency in a first of three possible votes in parliament, we do not see any substantive guarantees that Mr. Dimas will secure the supermajority (200 seats out of a total of 300) that he needs to win. In the event that he does not get elected in the first round on December 17, the second and third rounds are scheduled for 23 and 29 December, respectively.

Under the scenario whereby Mr. Dimas does not secure his nomination for head of state in all of the three possible attempts, this will inevitably lead to the government’s (and possibly the parliament’s) dissolution, prompting the call for early elections.

In the current state of play, investors are weary of the prospect that early elections could bring Syriza to power, a party that wants to renegotiate Greece’s sovereign debt and bolster public spending – a proposal that puts Greece’s creditors at the edge of their seat.

Mercosur summit: Bloc solidarity for macroeconomic woes?

On 17 December, the Mercosur trade bloc is holding a summit in Parana (Argentina) where leaders from Uruguay, Paraguay, Venezuela, Brazil and Argentina are expected to centre discussions on the impact of falling commodity prices on members’ economies.

We expect Venezuela to bring up its current macroeconomic woes to its Mercosur partners, with the possibility of reaching out to its counterparts in an attempt to secure financial help in the event that Caracas is forced to default on its debt, a scenario that is looking ever so likely.

Moreover, given the location of the summit, we also expect Argentina’s President Ms. Kirchner to gather up support from the trade bloc partners in assisting Argentina with confronting its holdout creditors, who prompted Buenos Aires to default on its debt in July. In this sense, we see the upcoming Mercosur summit focussing on the internal struggles of the trade bloc as it faces the mounting headwinds of the global economy.

Bank of Japan’s Monetary Policy Conundrum

On Friday 19 December, the Bank of Japan (BoJ) will conclude a two-day meeting during which it will announce its monetary policy decisions in the wake of a snap general election. With the expectation that Shinzo Abe’s Liberal Democratic Party (LDP) will win with ease, the BoJ governor is confronted with a policy conundrum.

While the drop in oil prices stands out as a godsend to the economy – due to the so-called “tax-cut” effects – this phenomenon threatens BoJ Governor Mr. Haruhiko Kuroda’s endeavor to quickly achieve the BoJ’s 2% inflation target. Indeed, softer oil prices could push Japan’s core consumer price index to levels as low as 0.5% next spring, exacerbating the country’s disinflationary woes.

Following the BoJ’s surprise QQE move on 31 October, the oil market has continued on a downward trend, as has the yen. In the event that the yen continues to depreciate further, on the back of mounting speculation that the BoJ will become increasingly reactive to the slide in oil prices, this could indeed halt the decline in the inflation rate, but the benefits brought about by the “tax-cut” effects emanating from lower oil prices would be annulled.

We expect the BoJ to continue to play it safe and favour price stability through tight monetary policy. Indeed, we would not be surprised if Mr. Kuroda plays by the Central Banker’s rule of thumb: do not respond to downward pressures on inflation from soft oil prices – the knock-on consequences are inevitably one of elevated rate of inflation in the long-term.

The GRI Weekly Risk Outlook (WRO) provides analytical foresight on the economic consequences of upcoming political developments. Covering a number of future occurrences across the globe, the WRO presents a series of potential upside/downside risks, shedding light on how political decisions impact economic outcomes. The WRO is put together by GRI analyst Jose Luengo-Cabrera.

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