Global Agenda: Fedomania

The legions of "Fed watchers" are waiting to see what wording the Fed uses to explain its decision and to present its assessment of inflationary pressures in the economy.

By PINCHAS LANDAU
On Thursday evening, i.e. after this article is written but before it is read, the Federal Reserve Bank will announce its decision regarding US interest rates. Although the twoday Fed meeting that will culminate in this decision has been the dominant focus of attention in the global financial markets throughout this week - and to a slightly lesser extent last week, as well - there is no doubt as to what that decision will be: For the seventeenth successive time since mid-2004, the FOMC (Federal Open Market Committee) will raise interest rates by 0.25 of a percentage point. What, it might then be asked, is all the attention focused on? The answer is that the legions of "Fed watchers" are waiting to see what wording the Fed uses to explain its decision and to present its assessment of inflationary pressures in the economy. Above all, everyone wants to receive some clearer indication of the Fed's course of action over the coming months. Therefore, the appearance, repetition or excision of specific words in the statement issued at the end of each Fed meeting is followed by the financial world with much greater intensity than the religiously devout attach to the pronouncements of their holy men. So influential is this statement, that a great debate has been underway of late as to whether the new Fed chairman, Ben Bernanke, is succeeding in communicating clearly with the markets - and what damage might ensue were he to fail to do so. Given this singular preoccupation, any suggestion that the actions, let alone the words, of the American central bank are not the most important factor determining how the global financial markets move would widely be considered as odd, if not downright heretical. Fortunately, there are such heretics around - and much of what they say is original and thought-provoking, which is certainly not true of the endless regurgitating of outworn clich s by the mainstream Fed-watchers. One of the most interesting examples of this counter-trend is Gavekal, a Hong Kong-based investment research and management company run by the brothers Gave - Charles and Louis-Vincent - and Anatole Kaletsky, a name well-known to readers of the London Times. GaveKal is a consistent source of unorthodox thinking, especially on the big issues such as the US current account deficit (no problem), the US dollar (set to rise) and other major topics. It is likely that their Asian location gives them a much better perspective of the world - as well as saving them from the narrow-minded Fedomania that holds sway in New York. In any event, they are essential reading, whether or not you agree with them. Recently, they turned their attention to a topic raised here in the past, namely what is happening to the oil money. They considered both sides of the equation - how do the oil consumers cover their rising oil import bills and what do the oil producers do with their swelling revenues? The Gavekal conclusion is that oil consuming countries, mainly the large developed economies, have financed their oil imports and oil stockpiles by borrowing US dollars (oil is priced everywhere in dollars). Producers, on the other hand, have taken these dollars and - being persuaded that the dollar is weak and likely to get weaker, so that diversification is highly desirable - bought other assets. These "other assets" include non-dollar currencies (euros, sterling etc.), real estate (especially in London and Europe generally), commodities (gold, etc.), bonds and equities. The huge quantity of money involved explains why the prices of all these other assets have been rising, at least until very recently - and why the less liquid these asset classes were (emerging market equities), the more their price rose. This analysis, which is far more complex than the conclusion presented above suggests, offers explanations for a whole range of puzzling features in the markets over the last two years - such as the "conundrum" of falling long-term US bond yields although interest rates were going up and the economy was strong. But its implications are especially surprising. First, if oil prices were to fall, the whole chain of borrowing and investing described in the analysis would unwind and perhaps collapse. Second, the developed world can now be described as short oil and short dollars. At some point, these short positions will have to be covered - and when that happens, the US dollar and US assets in general will rise in value, while overvalued deficit currencies (Australia, UK and perhaps Euroland) will stand exposed. Within this scenario, the Federal Reserve is a player, perhaps an important one, but certainly not a determiner of directions or outcomes.