Dregs in the Punchbowl…For Now

Fed chairman Bernanke didn’t refill the punchbowl today as some had expected, choosing instead to reiterate the message from the FOMC statement earlier in the month, that “the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.” While perhaps not as overt as the signal of QE2 at last year’s Jackson Hole meeting, the market seemed to think that the Fed stands ready to offer further accommodations, perhaps as soon as the September FOMC meeting. That meeting was expanded to a two-day meeting (Sep 20/21), to “allow a fuller discussion.” In the interim, the market is going to have to get by with the dregs provided by ongoing reinvestment of maturing assets.

Stocks originally sold off on Bernanke’s speech, then rebounded as the chairman’s words were evaluated by seasoned Fed watchers, familiar with the nuances of Fedspeak. Gold down-ticked modestly early on, then continued to retrace the sharp correction that commenced after the yellow metal set a new all-time high at 1911.69 on Monday. Gold closed on its highs for the day, with nearly 61.8% (an important Fibonacci retracement) of the entire correction from 1911.69 to 1702.95 recouped. Despite the volatility this week, gold ended up down just 1.3%.

If more Fed “juice” is indeed forthcoming, as the market clearly seems to expect, gold will likely continue it’s march higher. However, what do we really stand to gain? US Q2 GDP was revised lower on Friday to a paltry 1.0%, and that anemic growth was during the midst of the Fed’s QE2 campaign. I’m not sure that we can expect much better results if additional asset purchases are in the offing, and Bernanke himself has expressed concerns about further expansion of the Fed’s balance sheet.

There was an interesting article on the Project Syndicate website this week by Stephen Roach, entitled One Number Says it All. The number to which Roach refers is 0.2%, “the average annualized growth of US consumer spending over the past 14 quarters – calculated in inflation-adjusted terms from the first quarter of 2008 to the second quarter of 2011.” Roach goes on to say, “Never before in the post-World War II era have American consumers been so weak for so long.”

That is indeed a terrible number, perhaps even downright devastating for an economy that is 70% driven by consumption. It also drives home a point that I’ve been making for some time about deficit and debt projections being based on a wildly optimistic growth outlook. Roach concurs, saying, “persistent weakness in consumption and GDP growth puts the US economy on a much weaker growth trajectory than that which is built into the government’s long-term budget estimates.” The CBO just upped their estimate of the FY2011 deficit to $1.3 trillion, and that too is likely to be revised higher over time. Meanwhile, Congress compromised on the debt ceiling hike by promising to cut $917 bln in spending…over the next 10-years! The first rule for getting out of a hole: Stop digging!

As the US is saddled with an ever greater debt burden, the Fed may indeed be obliged to offer further accommodations ‘to infinity and beyond’ (to borrow a phrase from Buzz Lightyear), lest debt servicing costs become such an oppressive percentage of GDP that all-hope of recovery is dashed. But even with more easing, it is unlikely to end our consumption malaise. That won’t happen until household debt has been deleveraged and Americans are once again feeling secure in their jobs. Bernanke must be aware of this reality; and perhaps that figured into his decision today to keep his remaining powder dry and chastise Congress for its ineptness in crafting any kind of meaningful fiscal policy response. Getting out of the debt hole can not be simply left on the Fed’s doorstep as a matter of political expediency.

Monetary policy is a blunt instrument. The Fed does us no favors by printing money and artificially suppressing yields indefinitely through asset purchases, but our elected officials have done neither the Fed nor us any favors by shirking their responsibilities on the fiscal side.

Given the realities within the beltway, it is likely that we have years of slow growth and high unemployment ahead of us, with severe bouts of systemic risks to boot. If by some miracle, our lawmakers put their partisan ways aside and America takes her bitter medicine, its going to burn like hell going down, but we just might come out of this stronger on the other side. Arguably the former is far more likely; but however this ultimately shakes out, gold will continue to serve as a critical hedge and means of wealth preservation.
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August 26 (Reuters) — Russia’s central bank will offer gold-backed loans for up to 90 days at an interest rate of 7 percent, it said in a statement on Friday, expanding its lending facilities for dealing with any future liquidity crunch in the banking system.

The gold-backed lending was approved by the board of directors at a meeting on Friday. The rate on the facility is in line with the central bank’s Lombard rate on borrowing secured against high-quality bonds.

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August 26 (Financial Times) — Greece warned on Friday it may call off a proposed €135bn debt swap if fewer than 90 per cent of private investors sign up for the deal.

The warning came in a letter from the Athens finance ministry to 60 global governments, giving details of a swap and rollover plan agreed last month with European Union partners as part of a second Greek bail-out package.

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PG View: Greek bailout 2.0 seems to be falling apart on all fronts.

August 26 (MarketWatch) — Federal Reserve Chairman Ben Bernanke on Friday put off a lengthy discussion of the easing options available to the central bank until the next Federal Open Market Committee meeting late next month.

“The Fed has a range of tools that could be used to provide additional monetary stimulus,” Bernanke said.

These options were discussed in August and “we will continue to consider these and other pertinent issues…at our meeting in September,” Bernanke said.

Bernanke announced that the Fed had decided to expand its September meeting to two days – Sept. 20 and 21 – to review the pros and cons of further easing.

…Bernanke also criticized Congress, saying the recent debate over the debt ceiling had hurt the economy.

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August 26 (Financial Times) — The US Federal Reserve “is prepared to employ its tools as appropriate to promote a stronger recovery”, chairman Ben Bernanke said in a speech at Jackson Hole on Friday, dropping a broad hint that the US central bank will soon do more to support an ailing economy.

But Mr Bernanke avoided the emphatic language he used in a similar speech last year, and offered no detailed discussion of the Fed’s easing options, suggesting that he wants to manage expectations carefully of how much the central bank might do.

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PG View: I didn’t read the Bernanke speech as being any different than the FOMC statement earlier in the month: We’ve got the tools and we’ll use them if warranted. However, if the FT’s take is closer to the truth, it would certainly explain why gold rebounded to set new intraday highs.

August 26 (MarketWatch) — The gold market got just what it needed this week: a two-session, $135-an-ounce drop in prices and a stark reminder that the higher the price, the higher the volatility.

“Everyone knew that gold had gotten ahead of itself and we needed to blow away the speculative froth,” said Brien Lundin, editor of Gold Newsletter, adding that traders who sold gold on Wednesday weren’t buying gold for the long term.

…“As $100 becomes an ever smaller percentage of the gold price, and as market volatility in general continues to rise, I think it’s reasonable to expect more $100 days in gold,” said Peter Grant, senior metals analyst at USAGold-Centennial Precious Metals Inc.

…But Steven Evanson, chief executive officer at Evanson Asset Management, said he does not believe gold is in a bubble by any conventional definition of a bubble.

“Retail and institutional levels of ownership are very low, the financial press has been more negative than positive about gold … the 10-year chart for gold shows rises, corrections [then] further rises, and fundamentals and macros support gold — unlike bubbles where prices detach from value,” he said.

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August 26 (Financial Times) — US economic growth in the second quarter was revised down to 1 per cent amid pessimism over a prolonged slowdown.

The revision from a preliminary estimate of 1.3 per cent signals that what had been viewed as a “soft patch” in the post-recession recovery has extended into a protracted stalling of the economy. The economy grew just 0.4 per cent in the first three months of the year.

The figures from the Bureau of Economic Analysis were in line with market expectations. A wide swath of downbeat indicators released over the summer in sectors ranging from manufacturing to housing to the labour market have further diminished consumers’ and investors’ confidence that the pace of growth will pick up anytime soon. Demand has weakened as Americans tightened their belts and businesses have largely remained on the sidelines, holding back on hiring and investing in an uncertain climate.

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Chairman Ben S. Bernanke
At the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming
August 26, 2011

Good morning. As always, thanks are due to the Federal Reserve Bank of Kansas City for organizing this conference. This year’s topic, long-term economic growth, is indeed pertinent–as has so often been the case at this symposium in past years. In particular, the financial crisis and the subsequent slow recovery have caused some to question whether the United States, notwithstanding its long-term record of vigorous economic growth, might not now be facing a prolonged period of stagnation, regardless of its public policy choices. Might not the very slow pace of economic expansion of the past few years, not only in the United States but also in a number of other advanced economies, morph into something far more long-lasting?

I can certainly appreciate these concerns and am fully aware of the challenges that we face in restoring economic and financial conditions conducive to healthy growth, some of which I will comment on today. With respect to longer-run prospects, however, my own view is more optimistic. As I will discuss, although important problems certainly exist, the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years. It may take some time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals. In the interim, however, the challenges for U.S. economic policymakers are twofold: first, to help our economy further recover from the crisis and the ensuing recession, and second, to do so in a way that will allow the economy to realize its longer-term growth potential. Economic policies should be evaluated in light of both of those objectives.

This morning I will offer some thoughts on why the pace of recovery in the United States has, for the most part, proved disappointing thus far, and I will discuss the Federal Reserve’s policy response. I will then turn briefly to the longer-term prospects of our economy and the need for our country’s economic policies to be effective from both a shorter-term and longer-term perspective.

[full text]

Key excerpts:

…In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. We will continue to consider those and other pertinent issues, including of course economic and financial developments, at our meeting in September, which has been scheduled for two days (the 20th and the 21st) instead of one to allow a fuller discussion. The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability.

…Notwithstanding the severe difficulties we currently face, I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if–and I stress if–our country takes the necessary steps to secure that outcome.

…To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time. As I have emphasized on previous occasions, without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic and financial damage.1 The increasing fiscal burden that will be associated with the aging of the population and the ongoing rise in the costs of health care make prompt and decisive action in this area all the more critical.

…Finally, and perhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses. Although details would have to be negotiated, fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of those goals. Of course, formal budget goals and mechanisms do not replace the need for fiscal policymakers to make the difficult choices that are needed to put the country’s fiscal house in order, which means that public understanding of and support for the goals of fiscal policy are crucial.

…The Federal Reserve will certainly do all that it can to help restore high rates of growth and employment in a context of price stability.

August 26 (USAGOLD) — Gold has retraced more than 38.2% (important Fibonacci level) of this week’s correction, but gains faltered ahead of $1800, leaving the more important halfway-back point at 1807.32 protected. The market is eagerly awaiting Fed chairman Bernanke’s Jackson Hole speech on “Near- and Long-Term Prospects for the U.S. Economy,” which is scheduled to commence at 10:00ET. This morning’s bigger than expected downward revision to Q2 GDP sets the stage for the “near-term” component of his speech; the economy is barely growing so there is little hope for any immediate relief on the jobs front, which begets further economic weakness.

Most Fed watchers seem to think Bernanke will not overtly signal further asset purchases (QE3), but will likely remind everyone that further expansion of the Fed’s balance sheet remains an arrow in his quiver, to be drawn as economic conditions warrant. There is also some speculation that the Fed will seek to flatten the yield curve via a new operation twist. However, New York Times economist Paul Krugman believes that Bernanke and the supposedly politically independent Fed has been forced into inaction by outside political pressure.

Arguably that outside political pressure is reflective of the personal feelings of a large swath of American voters, who realize that printing money and using that money to buy bonds in order to artificially suppress yields is hardly a panacea for our economic woes; and may in fact do more harm than good. Those trade-offs are something that Mr. Bernanke himself has alluded to in the past.

• Bernanke’s Jackson Hole speech on “Near- and Long-Term Prospects for the U.S. Economy” scheduled for 10:00ET.
• US Q2 GDP revised down to 1.0%, below market expectations of 1.1%, vs 1.3% previously.
• Spain, Italy and France extend short selling ban.
• Germany import price Index 0.8% m/m in Jul, vs -0.6% in Jun; 7.5% y/y.
• Eurozone M3 sa +2.0% y/y in Jul, vs downward revised 1.9% in Jun.
• Spain Q2 GDP sa (final) confirmed at 0.2% q/q; 0.7% y/y.
• UK Q2 GDP (second release) confirmed at 0.2% q/q; 0.7% y/y.
• Switzerland KOF leading indicator fell to 1.61 in Aug, below market expectations, vs 1.98 in Jul.
• Singapore manufacturing production 7.4% y/y in Jul, vs 10.7% y/y in Jun.
• Taiwan leading economic index 0.0% m/m in Jul, vs 0.1% in Jun.
• Japan CPI (National) +0.2% y/y in Jul, vs negative revised -0.4% in Jun; Tokyo -0.02% y/y.

Brief:
(August 23, discussion) Gold’s ascent over the past few weeks has been remarkable. Following the downgrade of US debt by S&P, gold covered the distance between $1600 and $1900 in less than three weeks. Talk of gold being in a bubble quickly resurfaced as gold surged, but very little supports such conclusions. Net global investment in gold remains less than 1% of total assets, compared to levels as high as 5% in the 1960′s. Perceived safe haven currencies such as the Yen and the Swiss Franc are being forcibly suppressed, while the dollar and Euro remain under pressure. As Alan Greenspan said earlier this week, “Gold, unlike all other commodities, is a currency. And the major thrust in the demand for gold is not for jewelry. It’s not for anything other than an escape from what is perceived to be a fiat money system, paper money, that seems to be deteriorating.” Also discussed is Hugo Chavez’ effort to repatriate Venezuela’s gold from the Bank of England, setting the stage for other countries to attempt the same, raising questions about availability if this trend gains momentum. Last week was also the 40th anniversary of Nixon closing the gold window. — With Peter Grant, George Cooper, and Jonathan Kosares. 21min.

August 25 (Bloomberg) — The Federal Reserve’s decision to keep record-low interest rates and the possibility of more steps to stimulate the U.S. economy may boost commodity prices and fan inflation in India, the Asian nation’s central bank said.

“Given the fiscal limitations and growing signs of weakness in the U.S., the Fed has already indicated that it will pursue its near-zero rate policy at least till mid-2013,” the Reserve Bank of India said in its annual report in Mumbai today. “It has also hinted at another dose of quantitative easing. This policy stance may keep the commodity prices elevated.”

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August 25 (Reuters) — Greece’s central bank has activated an emergency liquidity assistance scheme so that it is available if banks need to draw from it, financial daily Imerisia wrote on Thursday without citing any source.

The Emergency Liquidity Assistance (ELA) is one of the options the euro zone has at its disposal to keep Greek banks afloat if the country’s sovereign debt is pushed into default by a new bailout deal that was put together by EU leaders last month, and the ECB stops accepting it as collateral.

…Rising bad loans, sovereign debt downgrades, deposit outflows and a deepening recession have taken their toll on Greek banks, which also stand to suffer write-downs from a bond swap deal that is part of the country’s second rescue package.

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By Mohamed El-Erian
Ben Bernanke, the chairman of the US Federal Reserve, is in a really tough spot. With other policymakers essentially missing in action, many hope that he will provide a remedy for America’s increasingly deep-rooted economic problems at Jackson Hole on Friday. Possibilities include enlarging the Fed’s balance sheet, extending the average maturity of the financial assets it holds and, even more controversially, expanding the range of assets it buys in the marketplace.

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Dollar Remains Weak, Despite Gold’s Correction

While gold has corrected dramatically this week, weighed by options expiration, another margin hike, as well as a generally overbought condition that resulted from the last several weeks of strong gains, the dollar remains on the ropes. The inability of the greenback to garner even a modest bid as gold retreated is indicative of the underlying dollar weakness.

In the above dollar index chart, it shows the greenback consolidating within a narrowing range throughout the summer. Breakouts from such chart patterns tend to come more often than not in the direction of the dominant trend; which remains unquestionably bearish. It is also worth remembering that the dollar recently set new all-time lows against the Swiss franc and Japanese yen, as well as new post hard-peg lows against the Chinese yuan. It’s hard to envision a scenario in which the dollar’s downtrend is going to be reversed any time soon, which in turn bodes well for the long-term uptrend in gold.

Over the past couple of months we’ve seen some pretty significant downward revisions to US GDP expectations. We’ve also seen US sovereign debt downgraded by one of the major rating agencies. And despite the debt ceiling deal early in the month, the CBO reported yesterday that the FY2011 budget deficit will be $1.3 trillion. That’s $1.3 trillion in the current fiscal year, versus $917 billion in spending reductions over the next decade that were negotiated. The new super-committee is tasked with finding an additional $1.5 trillion in spending cuts over the next 10-years, but the CBO reports that the government will accumulate an additional $6 trillion in debt over the same period. Bottom-line: We are saddled — and will remain saddled — with a massive debt burden for years to come.

None of this can be even remotely construed as dollar positive, and in reality a higher dollar is about the last thing our policymakers want right now. About the only thing that can turn the dollar around is a higher yield on US Treasuries, or perhaps a complete collapse of another major international currency (the euro leaps to mind). However, higher yields would make it increasingly expensive to roll-over our massive debt. As debt servicing costs rise as a percentage of GDP, it further hamstrings growth.

There are no real good options for Fed chairman Bernanke when he speaks in Jackson Hole tomorrow, which is why many think he will simply tow the FOMC line from the meeting earlier in the month.

August 25 (USAGOLD) — Gold extended corrective losses in overseas trading after the CMEGroup hiked margin requirements by another 27% late on Wednesday. The yellow metal set a new 2-week low at 1702.95 before finding support. It’s not uncommon to see markets hit into options expiration as the writers try to drive as many calls out of the money as possible.

Meanwhile, waning expectations that Fed chairman Bernanke will hint at further accommodations tomorrow when he speaks at the KC Fed’s symposium in Jackson Hole, have also contributed to unwinding of long gold positions. In light of recent weak economic data there were expectations that the Fed would indeed act to jump-start the economy, but such suspicions have been tempered by Washington Post, Wall Street Journal and Bloomberg articles this week that have discounted the likelihood.

• US initial jobless claims +5k to 417k in the week ended 20-Aug, above market expectations, from upward revised 412k in previous week.
• UK Nationwide’s consumer confidence fell to 49 in Jul, just 8 pts off all-time low from Feb, vs 51 in Jun.
• UK CBI Distributive Trades Survey (Realized) fell to -14 in Aug, below market expectations, vs -5 in Jul; Expected -7.
• Germany GfK Sep consumer confidence eased to 5.2, as expected, vs negative revised 5.3 for Aug.
• South Korea consumer confidence fell to 99 in Aug, lowest in 5 months, vs 102 in Jul.
• Hong Kong trade balance eased to -HKD35.9 bln in Jul, vs -HKD40.3 bln in Jun.
• NZ Q2 retail trade +0.9% (q/q), above market expectations, vs +1.1% in Q1.
• Philippine trade deficit -$376 mln.

August 24 (MarketWatch) — The CME Group Inc., the parent company of the main metals and energy exchanges in the U.S., on Wednesday announced an increase in margin requirements to trade gold. The money needed to trade gold contracts increased 27%. Initial margin requirements rose to $9,450 from $7,425 per 100-ounce contract; maintenance margin requirements rose to $7,000 from $5,500, both effective as of the close of trading on Thursday. The CME had increased margins for gold two weeks ago.

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August 24 (USAToday) — The Congressional Budget Office projects slow growth and high unemployment for years to come as a result of the financial crisis and recession, a new report shows.

In its semiannual update of budget and economic data, the agency — which serves as the official scorekeeper for President Obama and Congress — projects the jobless rate will fall to 8.9% by the end of this year but remain above 8% until 2014.

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August 24 (MarketWatch) — If gold was actually in a bubble, has that bubble popped? It’s a question some traders are asking today with gold GC1Z dropping by as much as $97 an ounce, or over 5%, but it’s probably safer not to read too much into the metal’s decline.

…But Austin Kiddle, an analyst at London-based bullion brokers Sharps Pixley, said Wednesday that the current downward movement in gold is “more in line with profit taking than a move out of safe-haven territory,” especially given that next month is a big month for gold as the Indian wedding season begins.

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August 24 (MarketWatch) — Gold futures dropped more than 4% Wednesday, trading below $1,800 an ounce and extending losses to a second day as a correction that started after five records in six sessions suddenly got much steeper.

Gold for December delivery dropped $80.20, or 4.3%, to $1,781.10 an ounce on the Comex division of the New York Mercantile Exchange.

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August 24 (Bloomberg) — Central banks, net buyers of gold for the first time in a generation, are likely to retain their holdings even if they need to raise cash to counter an escalating debt crisis, according to Morgan Stanley.

“Once they’ve sold, that’s it, and buying back would be extremely expensive,” said Peter Richardson, chief metals economist at Morgan Stanley Australia Ltd., who’s studied metals markets for 20 years. “They would rather have the backing of a rising asset within their reserve portfolios than use it to reduce debt.”

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August 23 (Financial Times) — A prominent member of Angela Merkel’s government has broken ranks with cabinet colleagues by calling on Germany to ask Greece to post billions in collateral in return for new emergency loans, following in the footsteps of Finland.

Labour minister Ursula von der Leyen, who is also a deputy leader of Ms Merkel’s Christian Democratic Union (CDU), said forcing Greece to put up securities would “ensure that agreements [regulating a second bail-out] won’t be broken”.

She made the suggestion in an interview with the Hannoversche Allgemeine, a German newspaper, and followed this with comments on public television in which she suggested Athens could post gold reserves or stakes in state-owned companies as collateral.

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PG View: Merkel continues to dismiss the need for collateral, but the German people realize that they got taken for a ride on bailout 1.0 and are probably disinclined to provide further support without something of value pledged in return. The surge in Greek yields to new record highs is reflective of the market perception that the risk of a Greek default has never been greater.

August 24 (Washington Times) — The government will run another $1.3 trillion deficit in fiscal year 2011, Congress’s chief scorekeeper said Wednesday — easily eclipsing the $917 billion in savings over the next decade lawmakers scratched out earlier this month in their debt-reduction deal and underscoring the deep challenge they face going forward.

And over the next decade, the Congressional Budget Office said, the federal government will rack up nearly $6 trillion in new deficits — far outstripping the $1.5 trillion in future savings the new deficit super committee is charged with recommending to Congress.

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By Neil Irwin
August 23 (Washington Post) — This time a year ago, Federal Reserve Chairman Ben S. Bernanke headed to an annual gathering of central bankers in Jackson Hole, Wyo., amid a faltering U.S. economy, a perilous global situation, and rising calls on Wall Street for the Fed to do something to address both.

Here we go again.

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