Greenspan Conundrum Risk Rising for Fed

As the Bank of Japan ECB add stimulus, Greenspan conundrum risk is rising for the Fed. According to money manager QIC Ltd, as the cash benchmark is increased by the Federal Reserve, risk bond yields will fail to climb, a repeat of the dilemma faced 10 years ago by the then Chair Alan Greenspan.

The Federal Reserve is set to tighten monetary policy while at the same time, the Bank of Japan, along with the European Central Bank plan to create more liquidity. As stated by Matthew Peter, chief economist at Australia-based Brisbane, which oversees the equivalent of over $60 billion, unless lenders can steer improvement in consumer and business sentiment in local economies as a way to soak up funds, that will enter the US.

If liquidity seeps into the US and there is a subsequent suppression of bond yields that it would imply, financial conditions too loss for the US economy would be created. As told to Sydney reporters, Peter believes that this type of scenario could prompt the Federal Reserve to lift its benchmark quicker than markets expect but also in a manner similar to what happened during the Greenspan era.

In 2005, Greenspan said that he faced a “conundrum” in which a flood of global savings helped keep long-term rates low, even though the Federal Reserve increased short-term rates in an effort to curtail lending.

While the Fed funds rate climbed from 1% at the end of 2003 to 4.25% by the end of 2005, the 10-year yield only rose 0.15% point throughout that same period. Once again, the US is looking to raise its benchmark following economic improvements while both Japan and Europe face risk of deflation.

As pointed out by Peter, there are significant similarities between today and the Greenspan era, likening the liquidity created by the European Central Bank and Bank of Japan to that provided by a savings soaked China 10 years prior. Although Peter’s central scenario did not involve Greenspan’s conundrum, he said the chance of it occurring again jumped roughly 10% to 20%.

Early this morning, the US 10-year yield hit 2.33%, down 0.7% since the end of last year. Fed Funds futures are pricing in roughly a 75% chance of at minimum, one increase in the case rate by the end of 2015.

Peter concluded by saying that although the Federal Reserve is changing course, there will be a $1.4 trillion increase in liquidity injections in 2015, approximately 40% more than what occurred this year. Without doubt, liquidity into the global economy is going up opposed to down. Now, it comes down to determining where the liquidity ends up.

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David Goldstein

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