Apart from the weather, this summer has been an improvement on last year in a number of ways. We’ve been basking in the success of the Olympics, with London lit up by the extraordinarily beautiful cauldron, rather than the petrol bombs of last August’s riots. Stock indices have been buoyant, in contrast to a year ago, which saw equities plummet as US policymakers bickered over raising the country’s debt ceiling. Although agreement was reached at the last minute, the unseemly game of chicken led to the US losing its triple-A credit rating after a downgrade from Standard & Poor’s.
Last week, Ben Bernanke, the Fed chairman, delivered his much-anticipated speech at the Jackson Hole Economic Symposium. Risk assets initially tanked in a knee-jerk response to the headline news that there was no explicit notice that further Fed stimulus was imminent. But as investors began to delve deeper, they took heart from the overall tone. Ben Bernanke insisted that the Fed’s interventions so far have boosted the economy, and that unconventional measures are an effective tool of monetary policy. Although he warned that the “bar for the use of non-traditional policies is higher than for traditional policies”, he wouldn’t rule out further asset purchases and said that the Federal Reserve would boost accommodation as needed for growth.
Perhaps most importantly, he stated that the stagnation in the labour market was a “grave concern.” The Federal Reserve’s dual mandate requires that the central bank acts to maximise employment while ensuring price stability. So Ben Bernanke has kept open the window for further Fed stimulus, with some investors believing that this could be announced as early as the Fed’s next meeting on 12/13 September. As a result, the initial sell-off was quickly reversed and equities and other risk assets ended higher on the day.
But, despite Friday’s strength, the Dow, Nasdaq and S&P were all lower over the course of last week. There are certainly signs that the current rally is losing its upside momentum. It is concerning that trading volumes have been low while volatility (as measured by the Vix index) is close to five-year lows, despite the recent strength of US stock indices. This lack of volatility suggests that investors are over-confident and has led a number of market participants to worry that equities may have seen their best levels for some time.
We are now looking ahead to the ECB meeting on Thursday, and the prospect of Mario Draghi and his colleagues taking a more interventionist approach. Unfortunately, Draghi may be forced by circumstances to promise rather more than he is able to deliver. But whatever transpires, the fact that central bank intervention is the major factor supporting equities is a tragic state of affairs. Four years on from the financial crisis we are still dependent on a zero (and in some cases a negative) interest rate policy together with regular bouts of money printing. Despite this, growth in the US remains tepid, while much of Europe is either in or close to recession. Growth is also slowing in China, and this weekend brought the news that China’s official Manufacturing PMI is now confirming the HSBC data in showing contraction.
The Eurozone crisis gets worse, rather than better and standards of living for the majority in the West are declining as
inflation in goods and services rises while wage growth stagnates. At some stage, central banks will have to start unwinding their balance sheets. When the Fed began discussing this in early 2010, investors panicked. Two years on and it is no longer even a topic of conversation.