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Greek drama not likely to waylay Federal Reserve

The United States Federal Reserve Board building is shown behind security barriers in Washington October 28, 2014. REUTERS/Gary Cameron

By Howard Schneider and Michael Flaherty

WASHINGTON (Reuters) - The fuse may be lit for a Greek exit from the euro zone but the fallout in the United States is expected to be modest and not enough to throw the Federal Reserve's likely September rate hike off course, said former Fed officials and outside analysts watching the latest turn in Greece's crisis.

Major U.S. stock indexes closed down about two percent on Monday following sharp declines in Europe and Asia, while yields on Treasury bonds fell as investors piled into U.S. debt, as is typical in times of overseas stress. But the gyrations in the markets were not dramatic enough to waylay the Fed, analysts said.

"They don't have to raise rates tomorrow morning," said Roberto Perli, a former Fed staffer and now head of global monetary policy research at consulting firm Cornerstone Macro. "We will see how the economy does, and if it does not look like this is going to be a big deal then it is squarely up to U.S. data."

Michael Cloherty, head of U.S. rates strategy at Royal Bank of Canada's RBC Capital Markets unit in New York, said events in Greece did not significantly change the outlook for the Fed.

"This isn’t a ‘watch Greece’ situation...While we have chaos in Greece, there are no signs of dramatic contagion yet, and that’s why it doesn’t change the Fed’s tone,” he said.

Talks between Athens and its creditors broke down over the weekend after Prime Minister Alexis Tsipras called a surprise referendum on the austerity cuts in an aid package proposed by Greece's creditors.

The crisis in Greece has been such a long-running saga that the financial system has had time to buffer itself against the worst.

When the possibility of a Greek exit from the euro zone first arose in 2010, it conjured the possibility of another global meltdown - with banks throughout Europe and the world on the hook through their holdings of hundreds of billions of dollars in potentially worthless Greek bonds.

In the intervening years, much of that debt has been rolled into loans from the International Monetary Fund and other European nations, with much of the remainder already discounted heavily through a negotiated writedown with private creditors.

According to the latest figures from the Bank for International Settlements, U.S. banks have a modest $12 billion invested directly in Greece.

Direct trade relations between the countries are also small, and years of recession in Greece have already taken their toll on any U.S. exporters dependent on the country.

Perli and others said the Fed will closely watch changes in the value of the dollar, a running theme in Fed commentary for several months now.

The run-up in the dollar over the last year nicked U.S. exports to an extent that surprised the Fed, and any new surge in the currency could mean another hit to exports and to jobs.

The U.S. employment report for June will be issued Thursday, ahead of the long Fourth of July holiday weekend. As long as that and other upcoming reports show continued strong job creation, well above 200,000 per month, the Fed would likely proceed with an initial rate increase in September, analysts said.

A White House spokesman on Monday said U.S. exposure to Greece was small and that the crisis did not pose a threat to the U.S. banking system. The Fed declined to comment on developments in Greece.


The confusion in Greece could, however, make the mechanics of any Fed rate increase trickier, if flows of capital into U.S. markets begin to spike or if an actual Greek exit pushes the euro zone economy back into recession.

The Fed may not delay its rate hike plans because of that, but it could make the management of markets more difficult, and cause longer-term bond yields to behave in unexpected ways - falling because of the inflow of capital, for example, at the time the Fed is trying to push them up.

That just highlights the risks of one central bank diverging towards higher rates when the rest of the world is struggling, something the Fed will need to prepare for.

"Somebody up there has a kind of playbook of the two or three possibilities and the ramifications of them, so they can follow a decision tree," said former Richmond Fed president Alfred Broaddus. "They don't want to be caught off guard...They want to be ready for whatever flow effects to the U.S. economy might be."

(Reporting by Howard Schneider and Michael Flaherty; Additional reporting by Jonathan Spicer in New York and Ann Saphir in San Francisco; Editing by Andrea Ricci)