Fed will be forced to look at the bigger picture, and it's a particularly bloody one.....

Wednesday 8th July 2015

Fed will be forced to look at the bigger picture, and it's a particularly bloody one.....

"Fed Rate Increase Ruled Out For 2015 by Traders on Greece, China", Bloomberg.com

After all the speculation regarding when the US Federal Reserve will begin its rate-rising cycle (September ? December?), Morgan Stanley has released a survey suggesting that such a move could be put on hold until next year. At the heart of it lies the deep concern over unfolding events in China and Greece, and over how a hike in US rates could only exacerbate those two crises. Just for good order's sake, a quick recap of developments over the last 24 hours :

China : Stock markets tumbled almost another 6% in the trading day, Hong Kong's Hang Seng Index posting its worst day for 7 years. Plainly, the emergency measures taken by the Chinese authorities are yet to have an effect, and trading was suspended in about 70% of shares.

Greece : New finance minister Euclid Tsakalotos was yesterday due to present a new draft of Greek proposals to his Eurozone counterparts. In the event, he arrived at the meeting with nothing but an embarrassed smile  --  which, needless to say, did not last long. The absence of any Greek plan elicited the strongest response yet from Eurozone officials. Mr Tsakalotos has been "asked" to have another go tomorrow. A summit has been called for leaders of all 28 EU nations on Sunday (not just the 19 Eurozone members mind, such is the threat to the European project as a whole). Sunday will be latest in a long line of D - Days, but this one looks like the real thing.

Hawks in the US, and there are still plenty of them, argue that the Fed should be concentrating on domestic economic considerations and that a continuation of robust growth in the US will necessitate

a rate hike sooner rather than later. Even if the data remains strong, this seems an increasingly narrow viewpoint and the Fed will surely have to take into account the ramifications of its actions on a global economy in such a precarious position. The minutes of the Fed's June meeting will be published today and will be scrutinized as keenly as ever, but events since that meeting may make much of the Fed's deliberations of the time redundant.

As the IMF points out, the strength of the dollar (up 20% against a basket of currencies in 12 months) has already had a hugely negative effect on US exports and has played a big part in the US's disturbingly high current account deficit, a danger that even the hawks recognise. Rising US rates and an even stronger dollar will inevitably mean global outflows of capital into higher yielding and SAFE US assets, distinctly bad news for emerging economies who will also face having to service dollar-denominated debt. And the last thing that tumbling Chinese stock markets (can we call it a crash yet?) and a bankrupt Greece needs is the world's leading economy putting up interest rates.

The Fed has much to ponder.

Just a quickie ..... If you get a chance, you should have a look at :

"If Greece leaves, the Euro will be fragile", The Financial Times, P.11

Well worth reading Martin Wolf's assessment of the options going forward and, in the wider context, of who's to blame for this wholly disastrous scenario. He's absolutely right to conclude it's not just Greece who's at fault here (and that some kind of debt relief is key to any genuine attempt to keep Greece in the Euro), and that may play a part in suggesting more generous terms than many in the Eurozone feel like contemplating right now. Perhaps most interesting is the conclusion that if Greece goes then the Euro will be fragile ..... Of course that's true, and on strictly political and humanitarian grounds might be considered by some a price worth paying. But as we discussed on Monday I think, what about the markets ? The perception that an irresponsible and recalcitrant member state has got away with blue murder, and the very possibility of others trying the same thing (domino effects etc), would do irreparable damage to the credibility of the single currency. There's a very strong case that the Euro would be less damaged by letting Greece go than by hanging on at any cost. That sounds hard-hearted of course, but if a Euro patched up with sticking plaster begins to unravel, some might say that it would have been the kindest course after all.