Europe blocks U.S. emergency exit door

By Emily Kaiser

WASHINGTON (BestGrowthStock) – Europe’s debt troubles are blocking the U.S. Federal Reserve’s emergency exit door.

Six weeks ago, a majority of the big banks that deal directly with the Fed thought it would raise interest rates before the end of this year. By last week, most predicted the first hike would come in 2011.

Minutes from the central bank’s most recent policy-setting meeting, slated for release on Wednesday, may offer some clues about how heavily Europe weighed on the Fed’s thinking.

“We hope the worst of the (European) fallout is that the Federal Reserve has to linger for longer in its present stance,” said Citigroup economist Robert DiClemente.

The Fed released a yawn-inducing statement after its latest meeting in late April. It kept its benchmark interest rate near zero, as was widely expected, and changed only a few words from its previous statement in mid-March.

But judging from officials’ recent comments, Europe is on their minds, particularly after a nearly $1 trillion rescue package failed to quiet financial markets last week.

Richard Fisher, president of the Federal Reserve Bank of Dallas, called Greece’s debt troubles a “wake-up call.” Charles Evans, who heads the Chicago Fed, said uncertainty in Europe underscored the need to keep borrowing costs ultra-low. Lawmakers said Fed Chairman Ben Bernanke told them he saw a threat to U.S. banks if Europe did not address the problem.

“Like the European Central Bank and the Bank of England, the Fed currently sees fighting off a financial crisis as the first order of business,” said Dean Maki, an economist with Barclays Capital in New York.

To help Europe, the Fed last week redeployed one crisis-fighting tool that it had previously put away — “swap” lines that give European firms access to U.S. dollars.

Euro zone finance ministers are scheduled to meet in Brussels on Monday as they search for the right message to soothe skittish investors.

Market fear, as measured by the Chicago Board Options Exchange Volatility Index (.VIX: ), has spiked this month, reminiscent of the darkest days of the financial crisis.

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Ironically, Europe’s debt woes have eased U.S. debt funding strains. Investors shunning risky assets have poured money into U.S. Treasury markets, driving down bond yields. In early April, the yield on 10-year Treasuries raced up to 4 percent, sparking worries that rising borrowing costs would cool the U.S. recovery. On Friday, it was just above 3.4 percent.

“This flight to U.S. Treasuries seems curious at first, since the U.S. fiscal deficit is broadly similar to that in the UK and Greece and notably larger than for the euro area as a whole,” Barclays’ Maki said.

The White House estimated in February that the 2010 U.S. deficit would amount to 10.6 percent of total annual output. In the euro area, 2010 debt will likely be a relatively more modest 6.9 percent of output, according to IMF data.

Were it not for the debt-induced financial market strains, the Fed might have felt differently about when to raise rates.

Its updated economic projections will be released along with the minutes on Wednesday, and are expected to show the central bank growing somewhat more sanguine about the pace of economic recovery.

The economy added nearly 300,000 jobs in April, business spending has picked up and even small companies that had been abnormally depressed showed more optimism in a recent survey.

At least one Fed official has been pressing for the central bank to do away with a long-standing pledge to keep interest rates extraordinarily low for an “extended period.” Kansas City Fed President Thomas Hoenig has dissented at the last three Fed policy meetings because he wants that phrase removed.

If the central bank needs any more incentive to hold rates steady, this week’s inflation data should offer yet another piece of evidence that price pressures are virtually nil.

Both Tuesday’s report on producer prices and Wednesday’s consumer price index are expected to show inflation barely budged in April, according to economists polled by Reuters.

Inflation pressures are slightly more worrisome in Europe. Britain and the euro zone are scheduled to report their inflation figures on Tuesday. Both are likely to show a moderate rise for April, although at a slower pace than in the previous month.

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(Editing by Dan Grebler)

Europe blocks U.S. emergency exit door