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S. Balakrishnan

What might upset the Fed's applecart are some dramatic global developments in the last few days.

THE timing couldn't have been better (or should one say worse).

As this is being written, the US Federal Reserve's Federal Open Market Committee will go into session with its timeworn agenda of deciding on interest rates. The consensus, of course, is that it will be more of the same, meaning another 25 basis points increase, lifting the Fed Funds rate to 3.5 per cent. The Fed has followed this straight and narrow path at every meeting since June 2004. And predictions are that this would be the norm for at least another two meetings. Why? Because the US economy is in fine fettle.

Non-farm payroll for July was 2.07 lakh - above forecasts and accompanied by a welcome upward revision of previous figures.

Economists raised their forecasts of third quarter GDP growth to 4.5 per cent. Inflation, though accelerating a bit, is still below two per cent at the core (ex-food and energy) level. Even Europe, the sick boy, is showing definite signs of a recovery. What might upset the Fed's applecart are some dramatic global developments in the last few days.

The US has closed its embassies in Saudi Arabia following information that they could be terrorist targets. Iran is going ahead with its nuclear programme over the objections of European nations who are trying to bring it within the ambit of regulation and inspection. On a lesser scale, outputs at some oil refineries have been affected because of maintenance and accidents.

The result was that the price of crude rose to over $64 a barrel in Monday's trading. If Iran's nuclear actions attract UN sanctions, there could well be a serious disruption to the world's oil supplies and prices of $80-100 would be no surprise.

An extremely negative reaction from markets would then be all but certain. Stock markets would crash and business and consumer confidence would go for a toss.

Mr Alan Greenspan, the Chairman of the US Federal Reserve, has seen all this before - not once but several times. And his response has always been the same - cut interest rates and flood the market with liquidity. He did it in October 1987 when stocks collapsed, 1998 when the hedge fund, Long Term Capital Management went down under and September 2001 following 9/11.

Thus, current happenings in West Asia and oil markets could make the FOMC pause and think and be reflected in their discussions. (Minutes are published two weeks hence). Inter-meeting moves are possible if things get really bad.

Still, as of now, there will be no significant change in the tone and wording of the post-meeting Fed statement except perhaps something equivalent to the Fed being ready if emergent conditions in financial markets necessitate policy-reversing actions.

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