WAITING FOR BERNANKE TO SURPRISE US
EQUITY markets continue to struggle. Last week, many major global stock indices dropped below a succession of significant technical support levels. The downside momentum appears to be picking up and so far any rallies have been unconvincing and on low volume.
Investors have plenty to fret about. Europe’s political leaders can no longer delay facing up to the limited and unpalatable choices available to them. Reprofiling, restructuring or outright default of Greek sovereign debt looks increasingly likely. Yet the damage this would do to the balance sheets of European banks and the European Central Bank itself makes it difficult to pull the trigger. The alternative is to continue to bail out Greece (and Ireland and Portugal) and hand the bill to the taxpayers at the financially stable core of the Eurozone. Unfortunately, there appears to be no end to this process – something that is becoming more apparent to citizens in the six remaining AAA-rated Eurozone countries.
Recent economic data indicates that growth is slowing in the US, while the Chinese authorities continue to apply the brakes to temper inflation. On top of this, the conclusion of the US Federal Reserve’s $600bn asset purchase programme (QE2) this month is weighing on equities. The political ramifications – both domestically and internationally – of additional stimulus could be very damaging for the Fed, with the risk of failure outweighing any potential benefit. But the Fed has a dual mandate to fulfil: price stability and maximum employment. The Fed chairman Ben Bernanke maintains that inflation cannot take off while unemployment is high, as there is no upside pressure from rising wages, while rising commodity prices are “transitory”. Additionally, the housing market is double-dipping which is deflationary. Consequently, further quantitative easing would seem inevitable as it is the only weapon the Fed has. But QE3 has to be a surprise for it to be effective. For this reason, we can expect the Federal Open Market Committee members to talk it down over the next few months. But if equities continue to fall; if the European debt crisis explodes; if the situation across north Africa and the Middle East deteriorates; if the damage at Japan’s Fukushima nuclear plant worsens; if China experiences a hard landing; or if US unemployment continues to rise, then the Fed will have the excuse it needs to attempt yet another economic reboot.