Double Bubble Trouble

Thu Nov 4 23:51:44 PST 1999

>Dennis R Redmond wrote:

>>This isn't likely to slow down
>>the EU much, since EU inflation plus real growth is around 4.5% (meaning,
>>monetary policy is fairly easy), but things could get very, *very* ugly
>>Wall Street over the next few weeks.

>The Washington Post's John Berry, a regular recipient of leaks from
>Greenspan, had a piece in today's paper
>m> saying that the Fed is unlikely to raise rates for the rest of the
>year. Greenspan gave a pretty enthusiastic New Economy speech last
>week, though larded with his usual qualifications towards the end. So
>the question is whether higher euro rates will force the Fed's hand.

Chatting with an old BoE pal last night, who was very much of the opinion that the Americans were in denial over domestic inflation, and that the "New Economy" rhetoric was the product of a few wet-behind-the-ears recent PhD recruits. He reckoned that the Yanks would not be raising rates any time soon, pretty much no matter what happened. In the medium term, the Americans can respond to any euro area rate rise by paying more for their money at the long end.

The following text went out to my clients yesterday:



Euro interest rates Raise today? A euro area interest rate rise today is quite possibly on the cards, with 26 out of 32 economist polled by Reuters expecting either a 25bp or 50bp rise. Meanwhile, the received wisdom on the Fed is that we?ll see nothing this side of Christmas.

Isn?t this a little bit back-to-front? A quick comparison of the US and euro area cycles would not lead you to believe that a rate rise was more likely in Euroland than the States. Even the Netherlands doesn?t really look like a case for immediate action. So what?s up?

In a case like this, probably best to take the simplest explanation. Which is ? that the Fed has missed the boat. Worried about financial markets, it has held off raising interest rates until too late in the cycle. Alan Greenspan will be remembered, not as ?genius Uncle Alan?, but as the guy who missed the last turn, created a bubble and made sure that interest rates had to rise higher and for longer than would otherwise have been the case. Sort of like a US version of Nigel Lawson.

Any ECB rate rise might knock back banks in the short term (we?d be looking at the Irish banks and Popular to cushion the impact.), but the boost to credibility would be very good for long term inflation expectations in the euro area. It?s our belief that long term inflation expectations are what really kill bank stocks in the long term, and this is a game that Europecan only win, relative to America.

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