Shrugging Bernanke on EU-IMF Impasse

<p>Negotiations at today’s Eurogroup meeting over disbursing €44bn to Greece remain underway. The sticking point is over whether to maintain the 120% debt/GDP target at […]</p>

Negotiations at today’s Eurogroup meeting over disbursing €44bn to Greece remain underway. The sticking point is over whether to maintain the 120% debt/GDP target at 2020, or to grant more debt relief by extending the target date to 2022 while tightening the debt/GDP target to 110% instead of 120% of GDP. The IMF is obstinately pursuing the latter position. The middle ground route, or haircut option (allowing holders of Greek debt to take losses), entails sticking to the 120% debt target but extending the date to 2022. And yet, no agreement to this point.

Markets are shrugging Bernanke’s speech to the NY Economic Club where he appeared to maintain the status quo over asset purchases. Aside from stressing the importance of averting the fiscal cliff, Bernanke said fiscal policy uncertainty was “already to be affecting private spending and investment decisions and may be contributing to an increased sense of caution in financial markets, with adverse effects on the economy.”

Referring to labour markets to have “substantial slack” may imply that prolonged asset purchases are in store. When the current Operation Twist program (simultaneously purchasing and selling $45bn in long term treasuries) expires in December, the Fed will likely bolster the existing QE program ($40 bn in monthly purchases of mortgage bond securities) by stepping up purchases of a fresh round of treasuries.

As long as the risk of the fiscal cliff is not completely shaken off, markets may require a continuation of existing QE alongside a fresh build up of purchases to compensate for the risk of seeing $600bn eroded from the US economy.

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