US government default 'could trigger global macro-shock'
Published 10/06/2011 | 05:00
The biggest risk to the world economy currently is the US government defaulting on its debt, said St Louis Federal Reserve Bank president James Bullard yesterday.
The issue tops reverberations of Japan's quake, high oil prices and Europe's debt crisis.
"The US fiscal situation, if not handled correctly, could turn into a global macro-shock," Mr Bullard said in an interview. "The idea that the US could threaten to default is a dangerous one."
Some Republican politicians have said a brief US default might be acceptable if it forced the White House to deal with large budget deficits, but few Wall Street analysts believe it will come to that.
But Mr Bullard is worried about reaction overseas if the US government would technically default -- basically delaying interest payments for a couple of days. That could happen in the absence of a political compromise on this year's budget.
"If it were just US markets, it might not cause too many problems, but we've got people participating in foreign markets who are probably not as tuned in to the US political situation," Mr Bullard said.
"The reverberations in those global markets would be very severe. That's where the real risk comes in."
On the economic home front, he said the recent spate of weak US jobs and other data that has spooked markets was likely to be a temporary blip. It could, however, cause the Fed to stay put for longer than expected after ending its $600bn (€413bn) round of bond-buying this month, he added.
The Fed's policy-setting panel will want to weigh data at its August and September meetings before deciding on the timing of a monetary policy tightening, said Mr Bullard, who does not have a vote on the committee this year.
"With the weaker data, it's fine to tell the story that you think things are going to pick up, but then you are going to want to see some confirmation of that," said Mr Bullard, who oversaw research at the St Louis Fed before becoming president in 2008.
A decline in inflation expectations from the first quarter "takes some pressure off" the need to tighten quickly, he said..
Oil prices, which Mr Bullard sees as the biggest driver for inflation, have come down as a risk premium stemming from unrest in the Middle East has dissipated, he explained.
Once enough data comes in to confirm the economy is strengthening, he said, the Fed is likely to start tightening by ending its programme of reinvesting bond proceeds.
That is unlikely to trigger a blood bath in the bond market, where benchmark 10-year yields recently dipped below 3pc.
The real risk is the "fiscal uncertainty cloud" and the potential US debt default. He can't do much about the fiscal crisis. "This is up to Congress -- it will bear responsibility." (Reuters)