The rally: deal or no deal?
by Buttonwood
THE Dow Jones is up more than 200 points as I write and even Europe managed some very healthy gains. That was despite the inaction
of the European Central Bank today although the bank stands ready to
act if things get (even) worse. (Plague of frogs? New ice age?) The
general hope is that the combination of weak economic data, falling
commodity prices, bank runs in Europe and signs of panic in developed
market bond yields will force the central banks into easing action. One
could conceivably see the Fed, ECB and Bank of England all act, along
with easier policy in several emerging markets, not to mention the
willingness of both the Japanese and the Swiss to try to cap their
currencies. By the end of the summer, we may have co-ordinated monetary
easing.
Stockmarkets have responded very well to such signals in the past. So much so that the strategy team at Morgan Stanley talks of "Pavlovian policy and doggy markets". One problem is that QE mainly works via lower bond yields. But if low bond yields were the answer to economic growth, the economies of America, Britain and Germany would all be in the middle of fantastic booms right now. Morgan Stanley suggests that
Richard Koo, the Japan-based economist, has long argued that QE won't work in a balance sheet recession and the focus should be on fiscal policy instead. Again, this faces a big political constraint. Raghuram Rajan wrote an interesting piece in the FT recently on the way that fiscal stimulus might be appropriate in some countries and not others, and could be targeted in different ways (encouraging workers to move homes in search of jobs, for example).
One senses that the markets will respond to any official action that is perceived to be sufficiently substantial and, just as important, immediate. Plans for stabilising the banking system in five years' time are not going to do it.
Stockmarkets have responded very well to such signals in the past. So much so that the strategy team at Morgan Stanley talks of "Pavlovian policy and doggy markets". One problem is that QE mainly works via lower bond yields. But if low bond yields were the answer to economic growth, the economies of America, Britain and Germany would all be in the middle of fantastic booms right now. Morgan Stanley suggests that
policy easing has a much greater chance of working in emerging markets, where credit systems still function and the economies are not burdened by the structural baggage now weighing on developed economies.The danger is that the newly-created money only goes into those bond markets already perceived as safe havens or it heads off to Asia. What might work (in the context of the euro crisis at least) is unconventional policy that targets the under-pressure bond markets in Italy and Spain, say by a commitment to cap yields at 6%. But that requires a political change of heart. If the price of such a commitment was fiscal union, that would require treaty changes, and thus referenda, and a whole new round of uncertainty.
Unconventional monetary policy may be an effective shield - it can defend against systemic breakdown - but not a good sword; broadly unable to encourage a return to normal credit creation, where monetary policy can work to stimulate growth.
Richard Koo, the Japan-based economist, has long argued that QE won't work in a balance sheet recession and the focus should be on fiscal policy instead. Again, this faces a big political constraint. Raghuram Rajan wrote an interesting piece in the FT recently on the way that fiscal stimulus might be appropriate in some countries and not others, and could be targeted in different ways (encouraging workers to move homes in search of jobs, for example).
One senses that the markets will respond to any official action that is perceived to be sufficiently substantial and, just as important, immediate. Plans for stabilising the banking system in five years' time are not going to do it.
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