Wow. What was that all about?
The S&P 500’s wild ride. Source: finance.yahoo.com.
For one thing, not the U.S. economy. Another thing not about: mortgage rates, just about back where they were before the stock market circus. Take it one piece at a time. …
Pay as little attention as possible to the stock market. It enjoyed a one-way rally for three years, and was way overdue for waves of profit-taking — for any reason or no reason at all.
But two fundamentals remain unchanged: If you sell your stocks, there is nothing useful to do with the money, just safety plays with little or no yield; and second, business conditions and earnings are still good, especially in the U.S.
With those two forces in place, it’s hard to get a deep unwind underway. To harm the real economy, stocks have to crash. The real economy may not be accelerating, but it is not slowing in any meaningful way.
U.S. manufacturing is very strong, aided by energy costs as little as one-third those of competitors overseas. September industrial production rose 1 percent.
Job market signals are super-strong but somehow misleading, not pushing wages up. Claims for unemployment insurance fell to 264,000 last week, a level triggering Fed tightening any time in the last 40 years. September retail sales fell 0.3 percent, yet another accurate sign of wage weakness. Housing starts are up 9 percent in nine months, but the whole shebang is apartments, not homes for equity-building.
If the U.S. economy is as-was, where’s the fire? Europe. Again. Linkage to markets here are strange but powerful.
Lou Barnes explains factors that could limit the Federal Reserve’s ability to tighten monetary policy.
The euro experiment has been a disaster because it requires economic changes beyond cultural tolerance. Non-German Europe has never been as productive as Germany.
For accounts to balance among 19 nations, the strong must adopt behavior reciprocal to the weak until the weak adopt the productive culture of the strong. For the euro to work, Germany must become consumer-based, inflation-tolerant and an importer. Italy, Spain and France must “reform”: shrinking their welfare states, making it easy to hire and fire workers, start and close new businesses.
Ain’t gonna happen. Never is a long time, but never.
The European Central Bank has bought time. It has given an insolvent euro-banking system enough cash to soak up sovereign debt still flooding from every treasury but Germany’s. Three years ago sovereign bonds all over Europe entered a fire sale, yields soaring. The ECB put out the fire by blustering, saying it would buy these bonds if markets dared to sell against it.
The ECB has not bought a single bond, and markets want to see the cash. The proximate cause of all the market hoo-ah this week has been awful economic news out of Europe, GDPs falling into recession and disinflation turning to deflation.
The telltale is bonds, not stocks. Eurozone bonds have decoupled again: German 10-years trade 0.82 percent, Greek 10s 8.90 percent (up a full point this week), Spain’s 2.20 percent and Italy’s 2.56 percent.
Global markets have caught their breath at week’s end because everyone assumes Europe will try something to save itself. However, markets also assume that so much damage has been done to real economies that nothing will work. This crisis will recur, and on shorter cycle than prior ones.
From Europe outward, effects caromed like a pool-table break. A new European recession is profoundly deflationary for the world, thus intercepting Fed intentions to raise rates.
Cleared for takeoff image via Shutterstock.
Markets and the Fed itself had adopted “liftoff” to describe the Fed’s initial moves above zero. Now we’re groping for new slang to describe a new Fed predicament: Any liftoff will be followed soon by a return to zero.
“Crash” is too strong, but “dead stick” is close. James Bullard, St. Louis Fed president — for months a big, fluffy hawk — this week said QE should be reconsidered.
ECB and Fed chatter will lurch markets temporarily, but the global bond rally reflects deep belief that the central banks have shot their wads. Now it’s up to economies themselves, and in Europe the possibility of political exhaustion with the euro experiment. The day it folds will be rough, but global recovery would follow.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
