Fed action gets a negative reaction as markets stay on a bear track downwards
Posted on 22 September 2011 with no comments from readers
What a difference a year makes! Almost a year ago the Fed rescued the financial markets from a seemingly inevitable autumn slump with QE2. Not so yesterday with a so-called $400 billion ‘twist’ that sent markets into a downward spin.
The Dow lost three per cent and in Asian markets Hong Kong saw its worst fall since 2008. Strange because the financial markets got what they expected in the twist operation and not the unexpected in the form of QE3.
Stimulus ineffective now?
Have we reached the point where stimulus ceases to be effective? You could ask whether QE1 and QE2 actually worked with unemployment still high and the US housing market still in decline, only with retail inflation moving up. But it is more than that.
Artificial economic boosts can shift growth from the future to the present to a degree but only at a cost of lost production in the future. We are now living in that future and starting to pay the cost with higher prices in the general stores and at the gas stations.
The Hong Kong reaction is very significant. China helped pull the world out of the 2008 crisis with its strong growth and massive stimulus package equivalent to half of annual GDP. The Middle Kingdom is now a bubble itself and about to burst as the financial crisis in Europe comes to a head.
And the precise nature of this crisis is something that financial markets are still reluctant to take on board. The contagion from Greece is obvious, just look at the downgrading of the Bank of America and Wells Fargo yesterday by Moody’s. This is an ongoing downward spiral across the global banking industry. And that is quite apart from the more direct immediate impact on borrowing costs in Italy, Spain and the smaller eurozone nations.
Market psychology
However, stock markets do not move in smooth lines. They exaggerate to the upside and to the downside, just as most journalists are want to do to please their all too human audience. That is because at the heart of the financial system human beings still press the buttons.
Yesterday during the Fed statement apparently Wall Street switched off its computers and went manual because of a fear that computers would over-react to this news. Well, judging from what happened perhaps the computers would have done the job better.
Leave the computers switched off and we could hit a bottom within a few weeks. That would push bond yields to another record low, rally the dollar, bring gold and silver down and of course leave the stock market very much lower.
Only then would Fed chairman Ben Bernanke risk the wrath of the most likely next President of the USA with ‘treacherous’ QE3. Would it then work?
