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S. Balakrishnan

"NEVER in history have so many owed so much to so few" was Winston Churchill's stirring praise of the RAF's defence of London from German bombing during World War II.

"Never in history have financial markets been spooked so much by two words" might well describe the mood on the eve of the US Federal Reserve meeting on Tuesday (December 9).

It has all to do with "considerable period" - the phrase used by Mr Alan Greenspan and his colleagues to describe their interest rate posture in the coming months. In its last post-meeting statement, the Federal Open Market Committee (FOMC) said that rates could and will remain on hold for quite some time. The levels of capacity utilisation and unemployment in the economy and the complete absence of any inflationary pressures would perhaps make this possible. This was reiterated several times by several Fed Governors.

The markets started thinking differently. Economic data, they believed, are too strong for the Fed to maintain a credible low interest stance for a length of time. Rates might have to be raised as early as the first half or 2004. Indicators of future interest rates started moving upward sharply. Thus, 12-month LIBOR, but a year hence, was quoted at well over 3 per cent compared to spot LIBOR of 1.2-1.5 per cent for tenors up to 12 months. In effect, the markets were pricing in a more than doubling of short-term interest rates.

Last Friday's employment report changed everything. Additions to non-farm payrolls were a modest 57,000 - well below forecasts of over 1,50,000. Jobs data seemed to be moving contrary to other real economy indicators. The market paused and took stock. Bond yields fell by 15-20 basis points across all maturities. The two-year note is back where it was - below 2 per cent before all the hype on early Fed tightening.

Clearly, Mr Alan Greenspan is not going to be hustled into raising interest rates. He has often spoken about the new paradigm of technology making possible productivity leaps and enabling businesses to keep prices and protect and increase their profits even amidst rising raw material and wage costs.

Words will continue to speak louder than actions. The Fed can be expected to be "satisfied" with the progress of the economy and the low interest rate stance in its latest statement due out on Tuesday.

But the dollar may have the last word. It has crashed against the euro, and, in the normal course, should have done so even against Asian currencies, which are kept artificially low by their Governments and central banks for export competitiveness. We could see a rise in US Treasury yields, not because of Fed actions, but because of portfolio shifts to non-dollar assets.

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