by The Economist
ADDICTS always crave one more hit. With stockmarkets slumping over the past two weeks investors hoped that the Federal Reserve would unveil a third round of “quantitative easing” (QE), the creation of money to bolster asset prices, on August 9th. The second round, announced in August last year, had triggered an equity rally in late 2010.
Instead of pure heroin, investors got methadone in the form of a commitment from the Fed to keep rates at their current low levels for another two years. While Wall Street managed a late rally on the day (the Dow gained almost 430 points, or 4%), the Fed’s hit gave only a brief rush. Share prices resumed their fall on August 10th.
There was a more sustained reaction to the actions of the European Central Bank, which started buying Italian and Spanish government bonds on August 8th. Though the size of the buying programme was unknown, the effect on the bond markets was dramatic. The Spanish ten-year yield fell from more than 6% to 5% within two days.
At least the central banks are having a positive effect, however temporary. Politicians, meanwhile, have left investors with serious doubts about their ability to handle the crisis. European leaders have moved from an initial stance of denial about the seriousness of the region’s debt problems through a series of sticking-plaster solutions as the rot spread. American leaders, for their part, flirted with the prospect of a default before reaching a deal that neither helped the economy in the short term nor did enough to improve the government’s finances in the long term.
Worse still, their approach has seemed chaotic. “Investors have ended up betting on the political outcome as opposed to making decisions on the basis of the fundamentals,” says Ian Harnett of Absolute Strategy Research, a consultancy.
There has been an inevitable effect on confidence. According to The Economist/FT global business barometer, a survey of business confidence, political risk is the second-biggest concern (after the economy) for executives. Between May and July, the proportion of businesspeople expecting global conditions to improve over the next six months fell from 38.3% to 23.2%; those expecting a deterioration rose from 19% to 33.7%.
Moreover, the Fed’s low-rate commitment is a sign of its concern about the health of the economy—hardly a bullish signal for stockmarkets. By the time it had reached its high for the year on April 29th, the S&P 500 had doubled from its March 2009 low. A setback was only to be expected, especially since government-bond yields (outside the euro-zone periphery) have been falling in recent months, marking concern about the economic outlook.
Bad omens
Risk aversion has also shown up in the price of gold (see chart 1), which has hit repeated highs, and in the strength of the Swiss franc, which reached a record against the dollar on August 9th despite the efforts of the Swiss National Bank to let it weaken.
In contrast, other commodity prices have fallen by 12% since April 26th. That is a potential silver lining for developed economies, since higher raw-materials prices have acted as a tax on consumers.
Less positive was the slide in bank shares, which have underperformed the broad market this year (see chart 2). On August 8th alone, Citigroup and Bank of America fell by 16% and 20% respectively. Further declines in bank shares on August 10th took Bank of America’s fall this year to 49% amid concerns it needs more capital.
Meanwhile American money-market funds are ever less willing to buy European bank debt. In a further sign of concern, shares in Société Générale, a French bank, fell by 15% on August 10th (see article); those of Intesa Sanpaolo, an Italian bank, fell by 14%; and the cost of insuring against European bank defaults rose sharply. There has also been a modest rise in the spread between the borrowing costs of European banks and of governments, though nothing like the gap in 2008, when banks were almost frozen out of markets.
In corporate-bond markets, the spreads over government bonds paid by investment-grade and speculative borrowers reached their highest this year. They have been driven by falling government-bond yields (see chart 3) more than by rising corporate rates.
Indeed, with the Fed committed to keeping rates close to zero, Treasury-bond yields are astonishingly low by historic standards. The American government is paying just 0.9% to borrow money for five years. Those rates are eerily reminiscent of Japan, where bond yields have been at rock-bottom levels for the past decade in the face of sluggish growth.
Such rates chime with the “ice age” thesis of Albert Edwards, a Société Générale strategist who has long predicted a Japanese-style crunch for the developed world. “Unsustainable private-sector debt mountains were transferred to the public sector in 2008 to prevent the adjustment to the Depression-era reality that the debt unwind would undoubtedly have brought about,” Mr Edwards wrote in his latest research note. “Yet, those debts are as unsustainable in the hands of the public sector as they were in the private.” Mr Edwards expects ten-year Treasury-bond yields to fall to 1.5% (they are currently 2.1%) before the “ice age” is over.
If the economic slowdown continues, the Fed may have to dole out the hard stuff, in the form of more QE, later this year. But many observers think that, as with the last round, it will have only a temporary impact. “QE helped to push up equity prices but those increases were based on the hope of a vigorous economic recovery that didn’t happen,” says Stephen King, chief economist of HSBC. Eventually, the markets will have to kick the habit.
No comments:
Post a Comment