Banker Bashing

21/06/2013 at 3:51 pm

On Wednesday, Fed Chairman Bernanke held a press conference. Making it clear that (in his phrase) the Fed would be “letting up a bit on the gas pedal” rather than hitting the brake, he announced that asset purchases conducted under the quantitative easing programme would likely start tapering off this year if the US economic recovery continued to show strength.

So far, so reasonable. QE is an emergency monetary measure designed to stimulate growth in desperate times. If the times no longer look desperate emergency measures are no longer required. Mr Bernanke’s announcement was a signal that the Fed’s view on the recovery has grown more positive. Some might describe that as good news.

Markets, however, did not see things that way. For them the story was the oncoming shrinkage of central bank stimulus. Since QE involves bond buying, bond markets sold off with the 10 year US treasury yield up about 30bp since the end of last week. Since some participants in the rather confused rush into owning gold had bought the metal out of fear that the QE programme would usher in hyperinflation and dollar collapse, gold continued its fall, closing below $1,300 an ounce for the first time in almost three years. And equity spiked lower again: the S&P 500 dropped by 2.5%, its biggest one-day fall in percentage terms since November 2011 (when Italy was thought to be on the edge of default), and losses in Europe were even worse.

Much of this behaviour is defensible in logic. But the reaction is also interesting for what it tells us about sentiment.

Back in the panic of H2 2011 the Fed got a similar bashing from markets when it announced a change to its QE programme. It wouldn’t be buying a greater quantity of bonds outright; it would simply be lengthening the maturity of the programme to move longer as well as shorter term interest rates lower. Dubbed “Operation Twist”, readers may remember that the market lurched lower – not because it didn’t like the idea but because the economic view put forward by the Fed as justification for the move was surprisingly negative.

In other words, just the opposite happened in 2011 as happened this week. Then, the market ignored the Fed’s intention to increase monetary stimulus and focused on its gloomy assessment of the economy. Now, the market is ignoring the more constructive economic view and focusing on the intention to reduce monetary stimulus.

This week’s stock market reaction has been bearish. Not as bearish as it was in September 2011: then, the fall after the Operation Twist announcement was 6%, not 2.5%. But it is bearish nonetheless. An American stock market which rallied on the back of the most consistently positive economic data period for some years has now fallen as the chairman of the central bank expressed a cautious view that this period would continue.

It is foolish to be dismissive of sentiment. Operation Twist succeeded in driving US mortgage rates to new lows, and housing market activity has picked up ever since. If bond market fears deepen and long term rates continue to go higher, some of that shine could be taken off over the next few months. But it is undeniable that fear is more rational at some times than at others.

During 2011 the US labour market was stalling, the Greek crisis brought fears of catastrophe in Europe and China was tightening monetary policy to contain an inflation problem. Today the US economic picture is so much more obviously confident as to be almost unrecognisable, the “European crisis” has not been remotely as bad as feared and the Chinese are keener to promote growth than stifle it.

Markets are equally in a much happier condition than they were two years ago. As a result, the opportunities are not quite so obvious as they were back then. But episodes like the current period of bearishness can still create them – with or without the help of press conferences from central banks.


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