A funny thing happened on the way to this latest turn in the Greek bailout tragedy: fed fund futures started pricing in expectations the Fed will hold off raising rates until 2016 vs. starting in September as previously expected.
"We have always thought it's one [rate hike in 2015] and it's September but this may push it back," says David Kotok, CIO of Cumberland Advisors which has $2.4 billion of assets under management. "The Fed does not know the impact that will come out of Europe - there are huge uncertainties."
Chief among those uncertainties is the potential impact a 'Grexit' -- or just more EU drama -- will have on the U.S. dollar. While down from its recent peak above 100, the U.S. Dollar Index is still up more than 19% from its 52-week low of 79.74 and seems poised for further gains, especially vs. the euro, if concerns over Greece prompt further weakness in the debts of Italy, Spain and Portugal. Beginning in January, the FOMC has cited "international developments" among the factors that will determine the timing of any rate hike and as far back as the September 2014 meeting, minutes show concern "that the appreciation of the dollar might also tend to slow the gradual increase in inflation toward the FOMC’s 2% goal."
Fast forward to the more recent past and here is a sample of what some senior Fed officials have said about Greece, the dollar and related matters, as reported by The Wall Street Journal:
- "I do see the potential for disruptions that could affect the European economic outlook and global financial markets. I would say that the United States has very limited direct exposure to Greece, either through trade … or financial channels. But to the extent that there are impacts on the euro-area economy or on global financial markets, there would undoubtedly be spillovers to the United States that would affect our outlook as well.” -- Fed Chair Janet Yellen, June 17
- “Negotiations between Greece and its creditors are challenging, and the risk of further deterioration cannot be ruled out. While the euro area has broadened its policy toolkit and most member states have made significant strides in building resilience in the past couple of years, the recovery is still fragile in several member states, and vulnerabilities to financial stresses remain.” -- Fed Gov. Lael Brainard, June 2
- “My own view is this is obviously one of those contagion risks we have to be concerned about.” - San Francisco Fed President John Williams, June 19
- “It is a fact that, to the extent we are the strongest, and the dollar increases in value, then … we will grow more slowly and monetary policy will react accordingly.” -- Fed Gov. Jerome Powell, June 23
Powell's comments came during a speech last week in which he also suggested the Fed might hike rates twice this year -- in September and December -- based in part on improvements in the labor market and a view that both crude prices and the dollar have stabilized.
"His conditions are 'yes growth, yes stable oil, yes stable dollar and we'll do a second one' but will he get the conditions? I don't think so," Kotok says. "We're about to see how the dollar soars."
Noting rates on excess bank reserves are negative in the eurozone and Switzerland vs. positive 25 basis points in the U.S., Kotok asks rhetorically: "Do you want to pay a fee to let your money sit in the bank or do you want to come to the U.S. dollar, come to the Fed through our banking system and get a rising trend, and rising interest rates? So the dollar gets stronger - the Fed does not know how much stronger," especially if it raises rates further away from zero.
Two key points:
- Kotok believes the Fed should raise rates and is already late in getting started. "You've got to get away from zero," he says, echoing comments made here. "Zero is distorting things. Get rates up 25 or 50 basis points so all kinds of market trades can clear at some price other than zero."
- Kotok remains bullish on stocks. "If the fed funds rate hits the dot chart estimates, it will be 100 basis points maybe 125 basis points, maybe 150 basis points at the end of next year," he says in the accompanying video. "That is still a very very low interest rate and very bullish for asset prices. Above that, with a pick up in inflation and increasing wage pressures and stabilities that Governor Powell talks about, then you begin to ratchet back the power of very low interest rates. We're not there yet, we've got plenty of time."
Indeed, and the bet here remains that it will take longer for the Fed to get there than most Fed officials and econo-pundits expect.