QE is off the table – for now.
Our financial system is nothing short of absurd.
We have a global marketplace, where millions of people trade countless different products, both real and financial. You can buy exposure to virtually any economy in the world, and any asset class you like.
An almost infinite number of variables are acting on this system at any given time. Everything from the weather in Bangkok to the mood swings of European finance ministers has an effect on it.
And yet, more than anything else, the price movements across this whole elegant network are dependent on one thing: the mutterings of a small group of men in a room in Washington DC.
So much for free markets…
The Fed and Spain Spook the Market
Wondering why the wind has dropped out of the markets’ sails in recent days? It’s mainly down to the Federal Reserve.
Minutes from the Fed’s latest meeting on monetary policy came out. In short, the Fed looks less likely to print more money than investors had expected. On the news, the US dollar shot up, gold slid, and stocks took a knock too.
Even the normally ‘dovish’ San Francisco Fed president John Williams noted that “the downside risks to the US economy have lessened”, and that “the arguments for doing another dose of monetary stimulus aren’t nearly as strong” as they were for the early bursts of quantitative easing (QE).
Obviously, the news that the real economy might be improving panicked investors. If that’s true, then they won’t get any more free money to punt in stock markets.
Things weren’t helped when an auction of Spanish government debt also had trouble getting away. This was doubly painful, because the Spanish government has committed to some pretty severe austerity measures. Whether you believe the country can do it or not, it’s at least making an effort.
What’s really worrying is that, as Justin Knight of UBS tells the FT, “the international investors who have left the Spanish bond market will probably not come back”. That suggests that the poor appetite for the bonds means that Spanish banks – the main buyers these days – might be “running out of LTRO money and therefore stop buying as well”, which would be “serious news for the market”.
Are Central Banks Really Going to Pull the Plug?
What does all this mean for your money? Let’s deal with the Fed first. We’ve pointed a number of occasions that QE3 might not be quite as readily available as investors had expected.
There are a number of reasons for this. One of Ben Bernanke’s stated main goals has been to drive up stock prices, and so make consumers feel wealthier. Given the first quarter rally, he’s certainly achieved this for now.
QE is also politically questionable. We’re in the run-up to a US presidential election. It’s quite tricky for the Fed to take any steps to boost the economy that aren’t easily justifiable. They’ll get accused of favouritism otherwise.
So what it comes down to is that QE3 is off the table until stocks tank again. That’s pretty simple.
So What Could Make Stocks Tank Again?
It strikes me that two things have underpinned the recent optimism in the markets. Firstly, the signs of a nascent recovery in the US. It’s still the world’s biggest and most important economy. If the good news can continue then that might outweigh the absence of QE3.
But there’s a second issue. Everyone has effectively assumed Europe away into the background. The base case is that there’ll be a recession there, but that there won’t be a systemic collapse, because the European Central Bank (ECB) will do what it takes to support the eurozone’s banks and sovereign governments.
I don’t necessarily think this is wrong. However, I do think the market is underestimating the amount of pain it’ll take to get to that point. And that brings us back to Spain.
The ECB is walking a much finer line than even the Fed. Mario Draghi is a more pragmatic man than his predecessor Jean-Claude Trichet seemed to be. But even Draghi can’t ignore the Germans.
Currently, European monetary policy is too loose for them. German unions are getting more aggressive with their pay demands. There’s even talk of a housing bubble. But if Draghi indulges Germany, then he throws Spain (not to mention the rest of the eurozone) to the wolves.
An ugly tug of war between Germany and the rest of the eurozone would rattle markets again. And if the ECB doesn’t step in to print money quickly enough, there’s every reason to think that Ben Bernanke and his friends might be forced to instead.
So in short, I don’t think the money printing is over yet. But there may well be another plunge in the markets before we get another dose.
John Stepek
Contributing Editor, MoneyWeek (UK)
Publisher’s Note: This is an edited version of an article that first appeared in MoneyWeek (UK).
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