On Friday, investors will get market-moving employment data as September nonfarm payrolls cross the wires.
Kelly doesn’t think the Fed’s “Operation Twist” is a good idea. The central bank is shifting its portfolio into long-term government bonds in an effort to force down interest rates.
“Since the start of August, the Federal Reserve has tried to stimulate economic activity first by assuring investors that short-term interest rates wouldn’t rise until 2013 and second by making adjustments in its vast security holdings to try to reduce mortgage rates,” the strategist wrote in a weekly outlook.
“However, given the obviously record low levels of interest rates already, it is hard to see how lower rates would encourage any borrowing. Meanwhile, the Fed has succeeded in conveying two very damaging psychological messages, first, that they are very worried about short-term economic prospects, and second, that borrowers can take their time in taking advantage of current low interest rates,” he added.
Kelly is also worried about what deep spending cuts would do to the fragile economy as politicians in Washington can’t seem to find a compromise on the pace at which the deficit should come down.
“As things stand right now, assuming that the ‘super-committee’ fails to come to an agreement, there is the potential for the deficit to fall from 8.5% of GDP in fiscal 2011, (which ended last Friday) to just 6.2% in this fiscal year,” he wrote. “The huge drop in aggregate demand which this implies would be due to the expiration of temporary tax breaks agreed to a year ago, combined with an end to the extra spending in the original Obama stimulus package and it is probably more severe than the economy can handle right now.”
Full disclosure: Tom Lydon’s clients own SPY.