Following the Fed’s announcement in August that Fed Funds would remain rock bottom until mid-2013, this will flatten the curve further. Given the current turmoil, we doubt that it will push investors back into more risky assets such as equities. Moreover, a flatter yield curve does not help ailing US banks and the maturity extension will make an unwinding of the Fed’s balance sheet in the ever more distant future even more difficult. The Fed pointed to significant downside risks for the US economy.
The preliminary EMU PMI for September falling to 48.4 gave the same message with regard to the EMU economy. That’s why we expect President Trichet will also twist at his final ECB council meeting before his retirement and cut the refi rate by 50 bps. Remember, he was already tapping his foot at the last meeting by highlighting the downside risks to the revised GDP forecast, which during the last few weeks have probably increased more than the ECB had already feared in September.
This was originally published by DB Research. Dr. Mayer is Chief Economist for Deutsche Bank Group and Head of DB Research.