Opinion

James Saft

The central bank cavalry isn’t coming: James Saft

February 4, 2014

Feb 4 (Reuters) – The pain is increasing in global markets,
but the likelihood of immediate relief from the Federal Reserve
and the European Central Bank isn’t.

A novel idea, that the Federal Reserve won’t send the
cavalry every time risk assets fall by a few percent, will in
itself be profoundly unsettling to investors used to conflating
their own wellbeing with that of the global economy. But with
transition to new leadership and no sell-off in critical
government bonds, it will take more than a few percent off
equities to prompt a U-turn on the Fed’s decision to trim bond
purchases.

The ECB is if anything less well positioned to provide balm,
though given its track record and the euro zone’s institutional
issues this will come as less of a surprise.

Developed market equities fell sharply on Monday, with U.S.
stocks adding to losses logged in January, taking the Standard &
Poor’s 500 index more than 6 percent below its recent
all-time highs. Emerging markets, which have been hit
with a sort of mini-crisis as the Fed tapers bond purchases,
also fell amid notable volatility.

While this all was likely touched off by the Fed’s decision
in December to begin to cut the amount of bonds it buys monthly,
there are some very good fundamental reasons for investors to be
concerned.

Data out of both China and the U.S. showed a sharp and, in
the case of the U.S., unexpected, slowing in the growth of
manufacturing.

In China, where the central bank is trying to rein in the
growth of credit in the shadow banking market, official data
showed manufacturing growth at a six-month low, and the service
sector expanding at the slowest rate since 2009.

In the U.S., where until recently optimism about
manufacturing was high, new orders reported by factory managers
fell by the most in 33 years. That may well have been a blip
caused by an exceptionally cold winter, but, twinned as it is
with disappointing job growth, it paints a picture of a less
robust economy.

And in Europe, where manufacturing data was a tad better,
inflation is low and falling, just 0.7 percent annually in
January, raising the possibility of deflation.

REMEDY FOR EVERY ILL?

While soft job growth, deteriorating manufacturing
conditions and a deflationary scare are not to be taken lightly,
especially when combined, the real wound, at least in terms of
securities prices, may be the fact that the Fed, at Ben
Bernanke’s last meeting last week as chairman, elected to reduce
further by $10 billion per month its purchases of bonds.

Many investors had hoped that turmoil in emerging markets
would prompt, at the least, some calming mention in the
accompanying statement of volatility or that the Fed was
watching matters.

That did not happen, the bad data did, and the developed
markets sell-off ensued.

It is important to understand that investors have been
habituated, like users of pain-killers, to relief from the Fed
when they show signs of even slight distress. The idea that the
Fed can’t and won’t always ensure steadily rising asset prices
may prove to be the slap-your-head lesson of 2014.

As for the ECB, which has a meeting this week followed by a
policy announcement on Thursday, any decision to address falling
inflation may have to wait. ECB President Mario Draghi detailed
two triggers for additional policy accommodation: deterioration
in the medium-term outlook for inflation or an “unwarranted”
back-up in interbank rates. Neither trigger has been fully met,
and while the ECB could in future get creative by buying
securitized bank loans or some other QE-like maneuver, it is
likely to want to do so with a bang and after stronger
provocation.

As for newly installed Fed chair Janet Yellen, she faces a
tough introductory period. There is no meeting scheduled until
mid-March, and even then she would be wise to reverse course on
the taper only with weaker economic data as justification. That
means we could have yet another weak, but not disastrous, jobs
report this Friday and still not be assured of a change in
policy.

Markets, therefore, will be left dangling, and investors
will not like it.

Like people after the discovery that the sun does not
revolve around the earth, investors face their own Copernican
shift: the bitter news that they are an instrument of monetary
policy rather than its sole aim.

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •