Warning From Europe: Fed Is Causing “Monstrous” Stress In The Global Financial System

The Federal Reserve is looking nowhere near raising interest rates this week, but by putting off another rate hike Chairwoman Janet Yellen and Co. risk setting the U.S. and the world up for another economic crisis, strategists warn.

Speaking at the Inside ETFs Europe conference in Amsterdam this week, several analysts argued the Fed should have started the tightening cycle years ago instead of letting outside events, such as China jitters, the commodity crash and stock market volatility determine the path of rate hikes.

“The Fed knows it is putting monstrous distortions on the domestic economy, because of the misallocation of resources that’s caused by having money mispriced,” said Kit Juckes, macro strategist at Société Générale.

I would argue that the Fed having rates that were too low in [2002-2006] caused monstrous misallocations of capital throughout the world, whose effects we felt in [2008-2015] and currently also in 2016 and counting,” he added. “If the cure to the downside of this is to have the same misallocation of capital, the only thing I don’t know is exactly where the problems will show up next. But I can see the Chinese boom followed by a bust, I can see the commodity boom followed by a bust, and I wish we could get back to an even keel.”

The comments come as the Fed kicked off its two-day policy meeting on Tuesday, with investors hoping for guidance on the future of interest rates. The central bank indicated in minutes from its late April meeting it was getting ready to hike rates as soon as June, a view that was later strengthened by a string of hawkish comments from several Fed officials.

However, after a disappointing reading on nonfarm payrolls in May, expectations of a policy change have been dialed back significantly. According to the CME Fed Watch tool, financial markets are only pricing in a 1.9% possibility of a rate increase.

Markets aren’t even pricing in a rise until December, which would leave a full year between rate hikes. But according to strategists, the Fed would only hurt itself if it waits longer to tighten policy.

“The longer they leave rates low, the greater economic and asset-class instability it creates. It’s a bit like having a concrete pillar, and you are pulling that concrete pillar with an elastic band. It doesn’t really do much, but eventually it snaps back and hits you in the face. That’s the risk of having too low monetary policy for too long,” said James Butterfill, head of research and investment strategy at ETF Securities.

He explained that among most dangerous side effects of loose policy is a hit to the banking sector because the low interest rates make it harder for the banks to make a profit.

“That ends up creating a poor lending environment and eventually that squeezes economic growth. That’s the unintended economic consequences,” Butterfill said.

The warnings on ultraloose central bank echo concerns raised at the international FundForum conference in Berlin last week. There, key fund manages warned central banks were setting the global economy up for another “Lehman moment”.

The Fed meeting wraps up on Wednesday with the rate announcement due at 2 p.m. Eastern Time and Yellen’s press conference at 2:30 p.m.