Trust the Fed ... But Verify
NEW YORK ( TheStreet) -- The economic recovery is gaining momentum, though the likelihood of a choppy, uneven path remains high.
The sustainability of the recovery is higher today than it was six months ago, and the underlying fundamentals are a plus. Even labor markets are poised for a gradual rebound in 2010. However, there are concerns that probably will persist throughout the year. The most pressing question involves the direction of the economy beyond 2010 and how the Federal Reserve's monetary and fiscal policies affect emerging moderate growth.
While the Fed continues to demonstrate no urgency regarding its exit strategy, I doubt things are as calm behind the curtain regarding options in 2010. The unprecedented actions the Fed has taken and continues to support are having an impact, from overseas equity prices to foreign-exchange markets. There are clear signs that less accommodation is going to be warranted sooner and not later. Therefore, I remain convinced that the pivot will begin in the first half of the year, and its execution is not without substantial risk.
The dangers are two-fold.On the one hand, the economy remains fragile. Removing support too quickly for the mortgage-backed securities market, tightening short-term interest rates or beginning asset sales will have a substantial impact on a vulnerable recovery, not only in 2010, but also in 2011. The second risk for the Fed is acting too slowly and struggling with financial-market pressure along with expectations. In prior cycles, the issue of managing market expectations and responding decisively has been a challenge. Given the unprecedented set of actions taken to deal with the crisis, effectively executing an exit strategy will be more delicate than anything the Fed has faced since the 1930s.
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