The past few days of trading have seen financial markets rocked by a realisation of just how fraught with dangers the US macroeconomic outlook still is – and the limitations on the power of the Federal Reserve to dispel them.
The core dynamic of the credit squeeze – financial sector weakness causing and then being amplified by economic weakness – has resurfaced. And it has been compounded by a resurgence of inflation risk, driven by record oil prices reports the Financial Times.
That in turn aggravates the growth threat, because it takes away what traders call the “Fed put” – the ability of the US central bank to use monetary policy to mitigate the risks to growth.
There are still some things the Fed could do. It could in the coming days expand its credit auctions, or extend the period for which they are available, perhaps from one month to three months. It could signal its willingness to extend the life of its emergency lending facility for investment banks, scheduled to expire in September.
It is already working on ways to make it easier for private equity firms to invest in banks. But it looks as if interest rate cuts are off the table, and the question is only when and how quickly the Fed will start raising them again.
Read more here: Inflation worry limits Fed flexibility