Why Market Moves Have Been Misguided

As U.S. stocks and the European equity index ended last week in positive territory, against a backdrop of disappointing data, market moves seems misplaced. Instead, Central Bank action is cosmetic not medicinal, a tool for reassurance not economic change. Developments from the recent EU Summit are either temporary or limited and capital remains restricted. However, economic deterioration heats up the pressure for action. Therefore, Central Banks are damned if they act and damned if they don’t. For sentiment to turn, we need to see signs of stability, as well as support.

Watch this being hotly debated on CNBC, with an entertaining edge…

Central Bank Action is Cosmetic Not Medicinal

Central bank action is being met with scepticism, and initial market rallies used as selling opportunities for profit taking. This is because moves are cosmetic and not medicinal, as in the short term they may reassure markets that measures are being taken, but they are of limited effectiveness at significantly boosting growth. Even Draghi himself, the President of the European Central Bank, argued “price signals (have) relatively limited immediate effect”. They won’t stimulate demand and, by potentially hurting bank profitability, could reduce the incentive to lend – the opposite of the target outcome.

Nevertheless, for the first time, we have seen the ECB cut the benchmark interest rate below 1%. In the same week, the Bank of England announced it will be increasing asset purchases by £50m. With weak US data and Bernanke already cautious, the pressure will be on to turn ‘Operation Twist’ into a more traditional waltz. Investors will be hoping the Fed will pump more liquidity into the system instead of ‘twisting’ or neutralising purchases by selling elsewhere along the yield curve.

Summit Moves Are Limited

The outcome of extensive talks at the EU Summit likewise fuelled a ‘false rally’. Spanish government bonds have since returned to hover around the unsustainable 7% level again despite developments. Instead, the 3 key ‘achievements’ are temporary or limited, as explained below…

1.     Senior not guaranteed: Investors have been moved higher up the pecking order and will now be repaid for loans made to Spanish banks before the bailout fund. Being the ‘first’ in line to get money back is indeed an improvement but crucially the risk of loss is still there and may continue to worry the markets.

2.     Wishful thinking? The government has been removed from the equation with bailout funds now able to offer loans to struggling Spanish banks directly. Removing government involvement in bank bailouts to protects sovereign bond yields ignores the possibility investors will continue to view the health of the banks as a driver of economic health.

3.     Bond buying boost limited: Bailout funds may now buy debt directly from “solvent countries” (read: Italy). However, this is a limited source of demand and again short-sighted.

Capital Remains Restricted

The size of the problem remains a key concern and a crucial measure missing from the Summit was a substantial strengthening of the ‘firewalls’. At €500bn, the rescue fund is only 20% of the €2.4tn combined debt burden of Spain and Italy. The risk that a lack of funding will leave European leaders unable to stop the crisis spreading remains.

Economic Deterioration Heats up the Pressure for Action

With a backdrop of a deteriorating economic environment, Europe is far from able to ‘grow out of the problem’. German manufacturing deteriorated for 4th consecutive month. Relied upon as a rare source of growth, the outlook is dimming. European unemployment has reached its highest level since the creation euro. This is unlikely to spur spending and instead put the pressure back on Central Banks to do something to kick-start economic growth.

Therefore, Central Banks are damned if they act and damned if they don’t. For sentiment to turn, we need to see signs of stability, as well as support.

Note some of this article has been published by the Financial Times



  1. I agree with Godfrey for her skepticism of the euro bailouts–and the impossibility of the situation. But for a quantum physicist, this \”blonde chick\” thinks very linearly. She justifies banking as legitimate just because there are a million innocent people employed in the industry, implying only a few bad apples are giving the industry a bad name. What she completely ignores is systemic rot and corruption in said industry (probably because she is a banker) and that the developed world has become over-financialized and overly dependent on DEBT. So yes, most bankers are innocent of wrong-doing, but the global financial system is over-leveraged, and there are no short-term or long-term solutions except default. When the nation’s GDP is $16 trillion, but its credit card bill is $220 trillion (see Dr. Kotlikoff), the US is insolvent–hence the repression (or fixing) of interest rates. The US–and especially her beloved UK, produces nothing of substance anymore–we\’ve become a society of lawyers, bankers and accountants. So while the euro may be in trouble, so will the pound and the USDollar (one can add the yen in for good measure). As Niall Ferguson says, and I\’m paraphrasing, \”it\’s safe–until it isn\’t safe anymore.\”

    I also don\’t appreciate the overall glibness of CNBC hosts and their guests. I guess they will finally get it when they are out of a job due to plummeting viewership ratings. As for bankers, since the retail investor has exited equities because they know a rigged casino when they see one, the sharks can no longer feed on the guppies. The sharks are now devouring each other (see Barclay\’s). I agree with Jim Rogers when he says bankers are a dying breed and it will be farmers who will be driving Ferrarri\’s going forward.

    Having said that, this very nice, smart, and pretty woman signed on to my twitter account, so she can\’t be all that bad. lol

    I just don\’t think I need another banker flooding my Twitter account with tweets. I do admire her for her cynical reflection on the very industry she\’s employed in–at least she\’s somewhat intellectually honest. She just doesn\’t take it far enough.

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