THE BIG PICTURE Fiscal policy coming to the fore in Europe As - TopicsExpress

THE BIG PICTURE Fiscal policy coming to the fore in Europe As the ECB gives in on monetary policy and announces more and more easing, the focus of attention is turning to Eurozone fiscal policy. ECB President Draghi Friday entered that debate when he said in his Jackson Hole speech that fiscal policy had an essential role to play in reviving economic activity to bring down unemployment. Then yesterday, French President Hollande dismissed his government after Economic Minister Arnaud Montebourg lashed out at fiscal austerity as the wrong way to go about fostering growth in the economy. If the anti-austerity movement does gain traction, it’s hard to say what the impact on the euro might be. Faster growth and higher yields would probably be euro-positive, but rising debt levels and falling credit ratings would be negative. Certainly the policy mix of looser monetary and fiscal policy has done nothing to help the yen recently. I think a looser fiscal policy is likely to be negative for the euro, at least initially, as investors worry about the loss of discipline, until eventually higher growth might convince them otherwise. In any event, it remains to be seen whether the troubled Eurozone countries can convince Germany that austerity is counter-productive. So far their arguments don’t seem to have convinced the Germans, but the pattern so far in the Eurozone crisis has been for Germany to resist and resist until finally giving in to almost everything. The market continues to adjust up its expectations for US rates. Fed funds futures for two years out and beyond were 2.5 bps higher, while the Treasury yield curve is flattening, with longer-dated yields declining and shorter-dated yields rising – the classic pattern that occurs in anticipation of tighter monetary policy. This is a good sign for the USD. Expectations of Fed tightening are likely to underpin the dollar, which in the past has generally registered strong gains six to nine months before the start of a tightening cycle.