Something has clearly changed in global financial markets in recent weeks. Not only have they been falling, but real world issues have begun to provide a negative impact. This sounds a strange statement. But it simply means that in the past, markets have seen “bad news” as being good news. They expected that it would force central banks to provide more stimulus, as the Boom/Gloom Index chart above shows:
- The first stimulus package in 2009 took the US S&P 500 Index up 61% between March 2009 – April 2010
- QE2 took it up 32% between June 2010 – April 2011: Twist took it up another 27% between Sept 2011 -Sept 2012
- Since then, an unbroken ride took it up 32% by July, as US, EU and Japanese central banks printed cash
The idea behind the stimulus programme was that creating a ‘wealth effect’ in financial markets would somehow lead to sustainable recovery in the real economy, as then Fed Chairman Ben Bernanke argued in 2010:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion”
In this, the Fed abandoned its historical role, as described by an earlier Chairman, William McChesney that:
“The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting”
Unsurprisingly, given the demographic headwinds, the new stimulus policy hasn’t worked:
- Japan still has a demographic deficit due to its ageing population. It is about to go back into recession, and is already back in deflation
- The US, UK and EU – also following it into demographic deficit – are also close to deflation, due to the combination of falling commodity prices and China’s New Normal policies
- And the latest Atlanta Fed estimate for Q3 GDP growth is just 0.9%, whilst Friday’s jobs report highlighted the underlying fragility of the US economy with the participation rate back at 1977 levels
And interestingly, one Fed Governor, James Bullard, has broken ranks with his colleagues and argued publicly for higher interest rates saying:
“The Fed cannot permanently raise stock prices (and)…its inappropriate to react to financial market turmoil. Historically the Fed has not wanted to react to this type of stuff and has tried to lay out a policy that’s more based on growth and labor markets…There is a powerful case to be made that its time to normalise interest rates.”
This is where the sentiment reading from the Boom/Gloom Index tells a story. It peaked back in February, and its subsequent rallies have never managed to return to this level. In turn, the S&P 500 has since peaked, breaking down quite sharply since July for its biggest fall in points since 2011.
Bullard’s comments don’t, of course, mean that the Fed won’t change its mind again as it did in 2011. It is highly likely to panic once again if stock markets continue to fall, and introduce more stimulus as QE4. But for the moment, traders are in the uncomfortable position of not being quite sure that this will happen.
They also have to worry that even if the Fed does move to QE4, along with the EU and Japan, some big investors may take this as a sign of panic. After all, real world issues such as China’s change of direction, Europe’s refugee and debt crises, and Syria’s civil war, cannot be solved by printing money and keeping interest rates low. So maybe, just maybe, markets are about to have to relearn this fundamental fact of life.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 54%
Naphtha Europe, down 52%. “Traders expect the low freight rates that recently opened up the arbitrage window to Asia to continue at least until November”
Benzene Europe, down 62%. “There have been considerable volumes of naphtha exported out of the ARA region to Asia for arrival in November, which has helped support European pricing.”
PTA China, down 44%. “ The reduced supply from plant turnarounds has not bolstered PTA prices”
HDPE US export, down 36%. “International resin prices seem to have stabilised at the current lower levels.”
¥:$, down 17%
S&P 500 stock market index, unchanged