Muted Greek Fallout So Far Offers Fed Little Reason for Concern

So far so good for the Federal Reserve as it surveys fallout from the Greek “no” vote. The financial chaos some predicted has yet to unfold, and the impact for now looks benign for the U.S. economy.

“The main way the Fed will look at it is to say, ‘These events abroad -- do they tighten financial conditions or do they ease financial conditions?’” said Torsten Slok, chief international economist at Deutsche Bank AG in New York. “The irony is they have eased financial conditions because U.S. rates have declined.”

While stocks and Treasury yields are lower, there’s no sign of panic in financial markets. For the policy-setting Federal Open Market Committee, the focus remains on whether the U.S. economy has enough momentum to sustain a moderate increase in short-term borrowing costs in September. At least one obvious risk -- a substantial shock to wealth from a downturn in financial markets -- hasn’t shown up.

That means Chair Janet Yellen, who speaks on the economic outlook this Friday and testifies before Congress for two days next week, can continue to watch the latest U.S. economic data and avoid hard conclusions about the timing of interest-rate increases for now.

Yields on U.S. 10-year Treasury notes slid to 2.31 percent at 1:30 p.m. on Monday in New York, down from an eight-month peak of 2.48 percent on June 10. The Standard and Poor’s 500 Index fell 0.6 percent. The dollar gained 0.3 percent against the euro as investors digested Greek voters’ rejection on Sunday of more austerity in return for aid from their creditors.

Domestic Data

Between now and Sept. 16-17, when the next FOMC meeting followed by a press conference is scheduled, Yellen and the committee will see two more monthly jobs reports and several fresh readings on inflation, housing and retail sales. They’ll also be keeping an eye on negotiations in Europe over Greece’s continued membership of the euro zone. Fed officials next meet July 28-29.

“At this point the Fed is just watching the situation evolve, much like the rest of the market,” said Gennadiy Goldberg, U.S. strategist at TD Securities USA LLC in New York. “They’re concerned because this could be a risk event, they’re just not sure of the magnitude yet.”

Slok and Goldberg are maintaining their calls for a September interest-rate increase by the Fed.

China’s stock market could be another concern. China suspended initial public offerings over the weekend, and its central bank said it would provide liquidity for margin trading after the Shanghai Composite Index tumbled 29 percent over the prior three weeks, erasing $3.2 trillion of value.

Mixed Reports

Fed policy makers say they want to see a mosaic of data that confirms that growth in U.S. employment is on a sound footing and that inflation is headed higher before they lift borrowing costs. So far, economic reports are mixed.

While job creation advanced in June, with the economy gaining 223,000 positions, wages stagnated and the labor force shrank. Inflation has been below the Fed’s 2 percent goal for more than three years.

The Fed has received early signs that U.S. consumers may be spending more freely, though, with personal spending advancing in May by the most since 2009. Growth in U.S. service industries picked up in June, according to the Institute for Supply Management’s non-manufacturing index released Monday.

The median forecast of the 17 participants at the FOMC in June was for two quarter-point rate increases this year. However, five participants forecast only one increase, while another five forecast two. In effect, a majority of the committee is divided between one and two rate increases this year.

December Liftoff

Economists at BNP Paribas in New York shifted their estimate of the first rate increase to December after Greeks voted “no.” That’s also the view of investors in money markets. Futures contracts also show a less than 40 percent chance of a rate increase in September.

“It isn’t just Greece, it is the domestic data,” said Laura Rosner, U.S. economist for BNP Paribas in New York. An “exceptionally strong” series of economic reports could raise the probability of a September interest rate increase, she added. “Right now, the economy isn’t where it needs to be.”

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