In the U.S., it’s obviously the market that’s controlling the Fed. For more than two years it has been promising to monitor the situation and come to the rescue if needed. But it has only considered itself to be needed if and when the market tells it so by plunging.
In 2010 it wasn’t until the S&P 500 was down 16% before it rushed in with QE2. Last year it wasn’t until the S&P was down 21% before it rushed in with ‘operation twist’.
This year, when the market rolled over into a correction on May 1, it wasn’t until the S&P 500 was down 6% and still dropping that the Fed became more aggressive with speeches and rhetoric outlining what it could do, and raising hope that it might do so soon.
But as soon as the market halted its plunge and started rallying again, the Fed calmed down and pulled back into the shadows. It surprised markets by doing nothing at last week’s FOMC meeting. Fed Chairman Bernanke spoke before a group of international economists in Cambridge, Mass. yesterday, and spoke only of the need to find better ways to measure the overall life satisfaction of citizens. Not a word about the economy or stimulus.
It does seem that it has no interest in doing anything about the economy unless the market dictates that it must, by plunging, and the market is content to rally because it expects the Fed has to come to the rescue with a big stimulus program very soon.
It’s been the same in Europe for more than two years. The markets control the actions of the troika (IMF, EU, ECB).
The euro-zone debt crisis was building three years ago, but was ignored until markets began plunging on concerns about Ireland and Greece. Only then did the EU and ECB rush in with loans and rescue efforts. Markets reacted positively, rallying back into their bull markets, and the central bankers returned to their do nothing stance.
And the process has continued, although the cycle between ‘crisis panic/rescue/crisis panic returning’ has become much shorter lately.
The two-year pattern has consisted of the Troika warning that the crisis was getting worse, but doing nothing until markets plunged into corrections on the increased worries. Each time the markets plunged the troika came to life and rushed in with rescue plans, the European Financial Stability Facility (EFSF), its successor the European Stability Mechanism (ESM), etc. Each time markets responded with rallies until it became obvious the latest rescue wasn’t working and plunged again, requiring yet another rescue plan to be introduced.
This year in Europe it was only when markets rolled over sharply in May that the troika jumped into action with promises again. They then backed off as markets seemed to recover briefly in reaction to the rhetoric. When markets returned more sharply to the downside a few weeks ago they rushed in with the EU emergency summit that resulted in another set of measures they promised would be the final solution.
Markets spiked back up, but soon sold off again when it was realized most of the EU’s plans would not be implemented until next year. At that point ECB President Draghi rushed in with his surprise statement that the ECB will do “whatever its takes.”
And European markets have been rallying again beginning with the big spike-up last Friday.
And now that markets are signaling they’re happy again, like the U.S. Fed, officials in Europe seem to be calmed again, no longer in a panic to do something right away.
In the news this morning, The Financial Times reports that Greece has been “forced to tap local banks for funding after eurozone partners rejected a bridge loan to repay a bond held by the ECB, and the ECB refused to delay the payment by a month, underlining the tough approach still being taken.”
It looks like the catch-22 remains in place in the U.S. and Europe. Markets are rallying again since Thursday on confidence that central banks will come to the rescue. Meanwhile, central banks continue not to come to the rescue unless markets force them to by plunging.
Subscribers to Street Smart Report: In addition to the information in the premium content section of this blog this morning, the new issue of the newsletter will be out tomorrowafternoon in the subscribers’ area of the Street Smart Report website tomorrow.
To read my weekend newspaper column click here: Central Banks Revealed They Are Now Impotent’, August 3, 2012.