Tags: Europe | Greece | Fed | FOMC

European Politics May Have Major Effect on Fed Decisions in 2015

By    |   Friday, 30 January 2015 01:42 PM

We have to wait until February 18 to read the notes of this week’s meeting of the Federal Open Market Committee. At that meeting, the committee decided it can remain “patient” before it starts raising the target Fed funds rate from the 0 percent to 0.25 percent target currently.

What struck me was the FOMC announced they will take into account “international developments” in their future assessments. Greece’s political developments have financial and geopolitical effects far beyond Europe’s borders.

We are on our way to debt disputes between the new government in Athens and the so-called “troika” that arranged to bail out the country if it maintained strict austerity measures. The troika consists of the European Commission, the European Central Bank and the International Monetary Fund. It is the biggest holder of Greece’s total 320 billion euro debt.

It’s really worrisome that euro zone officials don’t seem to know that a big part of the Greek population, and Greek Cypriots, has pro-Russian sentiments. For the long-term investor, it would be wise to notice that Greece on Thursday halted until September further extension of EU sanctions against Russia.

It’s far too early to talk about a possible Greek exit from the euro zone, or “Grexit.” The euro zone agreements don’t allow it, but as we all know nothing is forever even as ECB President Mario Draghi continues to say the euro is “irrevocable.”

If the new Syriza led Greek government gets most of what it was elected for, then we have to watch out for the Spanish elections on December 20. The opposition party Podemos is similar to Syriza in its stance toward the euro zone. If recent opinion polls don’t change dramatically, it could come to power, which may have dramatic consequences for Spanish debt holders.

I’d like to warn long-term investors who have or are considering to invest in euro-denominated instruments to remain extremely vigilant to what’s going on in Greece.

In March 2013, Cyprus Finance Minister Michael Sarris announced capital controls for a seven-day period and then promised to re-evaluate the measures later on. During this period, someone with a bank account in Nicosia couldn’t use euros the same way as someone who had euros in Brussels, Belgium. From that moment on, and this is extremely important, de facto a euro that was deposited in that period in a Cypriote bank had less value than a euro deposited in Brussels.

I’m not saying this will happen again, but if things in Greece should take a turn for the worse, we shouldn’t be surprised that “many” who have euros deposited in banks in the Eurozone periphery countries, which goes well beyond Greece, could “suddenly” very well remember what has happened in Cyprus in 2013 including the haircuts that were applied to deposits at Laika and Bank of Cyprus.

At that time, Jeroen Dijsselbloem, Dutch finance minister and president of Eurogroup of the ministers of finance of the Eurozone, said: “If there is a risk in a bank, our first question should be, ‘Okay, what are you in the bank going to do about that? What can you do to recapitalize yourself?’ If the bank can’t do it, then we'll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalizing the bank, and if necessary the uninsured deposit holders, which concerns the amounts above 100,000 euros. Now we’re going down the bail-in track and I'm pretty confident that the markets will see this as a sensible, very concentrated and direct approach instead of a more general approach.”

Take care when you see depositors start receiving a first stage higher yields to incite them to leave their euros on deposit in these banking institutions of the peripheral Eurozone while there is a generalized move to shorter maturities. You don't have to be a rocket scientist to see that these same depositors will be more prone to withdraw their capital at the first sign of concern. Believe me, if that were to happen this time around, this could have extremely serious consequences.

If the Greeks really play hardball this time, I wouldn’t be surprised the Eurozone sets up, once again, for a perfect storm. No doubt, in case that happens, this would have major global impacts and, maybe only in part, one of the reasons of the Fed could remain patient (with good reason) as long as risks that could generate from the Eurozone don't go away.

Don’t forget that a dollar that appreciates too quickly is harmful to the U.S. economy, but also to all those who have taken on dollar-denominated debt, such as many corporates in emerging economies.

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The Federal Reserve's statement that it will take into account “international developments” in its future assessments has significant implications resulting from European politics.
Europe, Greece, Fed, FOMC
Friday, 30 January 2015 01:42 PM
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