WHY THE FED SHOULD REMAIN ON HOLD

It’s been quite an innings in the currency markets now, with the tables finally turning in favour of the beleaguered dollar. While much of it surrounds the cliché “yield differential” argument, traders have virtually punished the euro and sterling for the same reasons they hammered the dollar not so long ago. Which again brings us to the question, should the FED succumb to the inflationary threat that sees its latest numbers hit a seventeen year high of 5.6% year over year?

To answer this, it would be worthwhile noting at the outset that it is still a lot premature to say that Uncle Sam is totally out of the woods, as the economy is yet to fully clean up the financial mess it has found itself in.

Sadly, much of the financial press tends to erroneously conclude that if the dollar is out of danger zone, so is the economy that it represents. However, any currency trader worth his salt would tell you, that currencies hardly reflect their intrinsic strength or weakness in the near term for the simple reason that the component of those invested in currencies pales in comparison to those speculating in them. For example, the astronomical rise in euro was not so much on account of any spectacular strength in the European region; rather it was driven up more as an anti dollar vehicle. If this is true, then we could even see a weird combination of rising dollar amidst a weak economy going forward. Here again not because of US economic strength but that weakness in the EU could get a lot more highlighted.

Much as was the whirlwinds that blew over the seemingly never sinkable US economy – the TITANIC of the economic landscape, the FED should by all means refrain from buckling to the pressure of hiking rates, particularly in an inflation-stained election year, even if it means sporting a negative real rate of return on its securities.

The continued monetary measures taken by the central bank since August 2007 in easing liquidity has helped soothe the financial strain at least to some extent. While a further round of easing may actually be needed, the central bank should at least keep rates on hold for some more time until the credit shocks stabilize and progress into a recovery that is both tangible and sure-footed. Any attempt at hiking rates immediately would be an impulsive response to inflation that would risk derailing any recovery either current or potential. With almost $3 trillion shaved off from American home values, it is hard to see how the US economy would be able to face a resumption of a restrictive policy.

It seems unlikely that Bernanke will undo what he has done this far in a manner that would render all his aggressive efforts futile. Any revisit in interest rates higher in the near term would bare open the risk of morphing the current bump with recession into a full blown depression for the US and the global economy following suit. Interest rates across the globe are likely to be headed south and the hunger for yield will continue to remain the unchallenged pursuit of every economic entity.

I end with the proverbial “If the US sneezes, the whole world catches a cold” to fall back on , and say that what the FED does in the next couple of months would either shape or mar the global economic framework for the next 5 years.