Washington: The US Federal Reserve will now have to contend with a potential flood of money from investors looking to the US as the global economy’s sole bright spot.
US bond rates have been falling in recent months. Hundreds of billions of dollars that will be created by the European Central Bank (ECB) and potentially other banks in coming months may be headed this way, meaning even more downward pressure on market rates and dollar strengthening that the Fed will have to deal with when it decides to hike.
There are other risks as well.
If Europe, Japan, China and other economies fail to respond to more stimulus, it would reinforce the notion that the world has moved into a permanently lower gear, so called “secular stagnation” — a bad omen for US wages and growth.
The World Bank also warned last week that developing countries “may be tested” in coming months if investors decide to shift from emerging market stocks, bonds and businesses into US assets.
In the tidal struggle that is developing over the direction of global interest rates, investors last year already pulled a quarter of a trillion dollars out of emerging markets, according to a recent report by the Institute of International Finance (IIF).
Cross-border investment is expected to fall again in 2015 as a Fed policy shift approaches, according to the IIF. “We have not lived through a period of such wide monetary policy divergence ... We don’t have a good road map for how this plays out,” IIF chief economist Charles Collyns said.
If Fed tightening proceeds, it could lead to market turmoil, potentially undermining global growth and, in the extreme, the US recovery. “The markets could wake up one day and make a substantial and abrupt move and it could have quite a negative impact,” said Collyns.
