Expectations Management

The commodity markets taking a breather and weak stock markets around the world have turned the focus from euphoria to caution, quickly. The Fed finds itself in a difficult spot. Having lifted inflation expectations and asset markets, they now must lean against the results. One way to look at the problem is to say the Fed forecast is now "The market is wrong." If inflation expectations are too high, then the Fed's gambit isn't working.  More importantly, a delicate balance and a long period of stability would be needed to generate employment from these inputs.

The context in which money would flow out of the commodity/PM space is critical. A soft and orderly adjustment is hoped for but hardly ensured. Even this slight change has delivered a rapid 10bp drop in the forwards for early 2012.  Expectations management is a difficult policy after years of crisis management actions. A period of "neutral" policy would require lower expectations for prices and some restraint on equity valuations. The combination seems the low probability event. For now, the tone has moved decidedly toward the defensive.

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