Tags: Fed | Greece | euro | Brussels

Euro Stability Is a Temporary Phenomenon

Friday, 20 February 2015 09:51 AM Current | Bio | Archive

The minutes of the January meeting of the Federal Open Market Committee (FOMC) could be qualified as relatively indecisive, as has been the case as of late.

That said, some wording caught my attention when I looked through it: "The increase in the foreign exchange value of the dollar was expected to be a persistent source of restraint on U.S. net exports, and a few participants pointed to the risk that the dollar could appreciate further. . . . The slowdown of growth in China was noted as a factor restraining economic expansion in a number of countries, and several continuing risks to the international economic outlook were cited, including global disinflationary pressure, tensions in the Middle East and Ukraine, and financial uncertainty in Greece. Overall, the risks to the outlook for U.S. economic activity and the labor market were seen as nearly balanced. . . . The Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate."

The conclusion is that nothing is moving on the Fed's monetary policy front, which means the first move toward normalization is still somewhere out there in the foreseeable future, although nearly all Fed officials expect the Fed to raise rates sometime this year.

Maybe what would be more interesting is to take notice of the comments of St. Louis Fed President James Bullard, who is a known "hawk" and is a non-voting member of the FOMC, made on Thursday when he warned that if the Fed waits too long to start the monetary policy normalization process, this could spell a "harrowing and disruptive" time for the Fed as well as for the U.S. economy. Bullard explained he doesn't feel comfortable at all because markets could abruptly come to the conclusion the Fed has fallen hopelessly behind the curve.

Once such a wake-up call comes, yields are at serious risk of being bid up in a strong fashion, which would leave the Fed with no other choice than to raise interest rates more rapidly than it probably would have liked to do. In simple words, if that were to happen then it's certainly not an overstatement to say the Fed as well as the U.S. economy could face real challenges.

Bullard's standpoint is understandable because first, he expects U.S. unemployment to fall below 5 percent in the third quarter of this year, and second, the Kansas Fed calculated the Trimmed Mean personal consumption expenditure (PCE) inflation rate, which is an alternative measure of the core inflation rate of PCE, remains at 1.6 percent, which is, in his words, close to Fed's 2 percent target.

You don't have to be a Fed banker to see these facts don't go together with a continuation of the Fed's "money for nothing" policy, which undoubtedly implies distorting effects (unrealistic pricing) in several markets.

Remember persistently low long-term interest rates usually lead to false market signals that, in the end, create the risk of opening a gap between financial hope and economic reality, while in the meantime the so-called "hunt for yield brainwash" has short-sighted many investors who have pushed aside doing their homework on the real investment fundamentals criteria.

The longer that kind of situation goes on, the worse the final outcome will be.

As the German philosopher Friedrich Schiller said: "Nothing leads to good that is not natural." No, I don't think too-prolonged quantitative easing (QE) is a sound form of "normal/natural" monetary policy.

We'll see if the Fed will pay attention to Bullard's early warning.

Finally, it's too early to have a serious idea on what could come out of the discussions Friday in Brussels with Greece and the Eurogroup.

In my view, the clearest, but also a very uncompromising statement came this week from German Finance Minister Wolfgang Schaeuble, who told the German public service television broadcaster ZDF: "There is no loan agreement for Greece, there is a bailout program. It's not about extending a credit program but about whether this bailout program will be fulfilled, yes or no."

In other words, the only deal the hardliners, which are Germany, Finland, Austria, the Netherlands, Slovakia etc., want to offer is extending the existing program that ends on Feb. 28.

For investors it's important to keep in mind that if no deal comes out of Brussels, Greece could install capital controls, as was the case with Cyprus in 2013, which was able to introduce capital controls without being ejected from the eurozone. This result would probably be the least bad solution for Greece.

For investors who have interests in where the euro could go from here, it looks to me the current relative stability of the euro will prove nothing more than a temporary phenomenon. This is mainly because the European Central Bank, not the Greece situation, will start its own QE program in March, which should have a weakening effect on the euro.

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The minutes of the January meeting of the Federal Open Market Committee (FOMC) could be qualified as relatively indecisive, as has been the case as of late.
Fed, Greece, euro, Brussels
Friday, 20 February 2015 09:51 AM
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