Greece's Impact on the Fed

It occurs to me that the two most prevalent event risks today—the ones I highlighted in this weekend’s update—possess substantially negative correlation. Here’s what I mean:

Greece:

Should Greece exit the Euro, global markets will surely sell off in notable fashion. As I type, Asian stocks are trading 2 to 7 (yes, 7!) percent lower and Dow futures are signaling a 250 point drop at the open tomorrow morning.

The Fed:

One of the transmission effects of monetary policy is its presumed impact on asset prices. Make money cheap and easy, the theory goes, and folks will spend and companies will profit and their stocks will rise. Reduce interest rates (the “cheap” part) and folks, in search of better returns, will invest in stocks and real estate, pushing up their prices. Folks with portfolios of higher-priced stocks and real estate feel wealthier. And wealthier-feeling folks tend to go out and stimulate economies.

As I’ve been suggesting from the beginning of the year, I see the Fed as the most likely catalyzer of what is surely a long-overdue correction (-10+%) in U.S. stocks. I.e., if the Fed moves (raises its benchmark rate) before the market anticipates, I see short-term pain resulting.

I believe that Janet Yellen and company, in many respects, are itching to raise interest rates. However, I also believe that they greatly fear roiling the financial markets and killing the wealth effect—just when the economy is finally beginning to find its legs—in the process.

Do you see the negative correlation? The Greek crisis becoming a true crisis can, by itself—as global markets are signaling at this very moment—do a number on the wealth effect. Thus, there’d be absolutely zero chance the Fed would raise interest rates amid the turmoil.

On the other hand, should, for example, the Greek people vote next Sunday to stay in the Euro and accept their creditors’ bailout conditions, I can almost promise you that any negative wealth effect occurring between now and then will be more than compensated for in very short order. And, thus, a Fed rate hike will be firmly back on the table for later this year. 

My point? As the Peoples Bank of China exhibited over the weekend (an interest rate cut in response to a recent steep selloff in Shanghai-listed stocks) today’s central banks are in no mood for financial market turmoil. And as you’re about to witness, they are more than eager to do whatever it takes to keep little old Greece from sparking the next great recession/bear market.

I’ll no doubt be addressing the potential longer-term perniciousness of such aggressive intervention in future blog posts. I.e., be careful what you wish for!

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