Can Ben and Mario save the world?
Ben Bernanke head of the US Federal Reserve and his counterpart at the European Central Bank, Mario Draghi, have vowed to do whatever it takes to meet their respective goals. For the ECB it's saving the Euro and for the Fed it's bringing down US unemployment. Though delighting holders of risk assets and risk currencies – these commitments do carry some big risks.
Firstly, the Fed, much like the Bank of England in recent years, now seems to be ignoring inflation. One of the unfortunate side effects of quantitative easing for Western consumer driven economies is that it pushes up prices of commodities such as oil, which diminishes discretionary consumer spending power. Should inflation become entrenched that could result in stagflation, a nasty combination of rising prices with no real economic growth or even contraction.
The second risk is that US employment and Eurozone economic growth do not respond sustainably, which is possible. The West's economies remain deeply scarred by the financial crisis, are still deleveraging, consumers are not increasing spending and firms are not boosting investment. And a third risk is that all this extra liquidity could create more asset bubbles, the bursting of which would create more problems. Such an outcome would badly dent the credibility of central banks.
Meanwhile, gold is likely to benefit from central bank largess and could hit the $2,000 per troy OZ target by Q1 2013, especially as the US dollar falls with a return to a 'risk on' focus by the markets. Last week's Fed statement made US employment data even more important than it was before with each release to be watched with even keener anticipation as traders try to interpret it's impact on monetary policy – whilst the importance of inflation data may be downgraded.
If the current monetary policies don't work there will come a point where central banks either engage in more extreme forms of quantitative easing, such as pushing money directly into the real economy, or simply give up. Whatever the outcome intense volatility looks likely to remain a key feature for 2013 as well.