A Nightmare on Wall Street

26^th October 2012

This blog was first published in Portfolio Adviser on 26^th October 2012 and can be found following the link:

 

http://www.portfolio-adviser.com/economics/nightmare-on-wall-street

Halloween is just a few days from now and investors remain spooked by fears of a deceleration in global economic growth. From West to East, central banks are scared too and have recently sanctioned further monetary stimulus, together for the first time since 2009. Mario Draghi, president of ECB, launched a scheme he called Outright Market Transactions (OMT), a facility which will allow the ECB to purchase a potentially unlimited amount of sovereign bonds of any member nation that requests aid. The prospect of this action has already been instrumental in driving down the short and medium term borrowing costs. The next step will require member nations officially to request aid.  In the case of Spain the government is frightened of forcing further austerity on an already distressed population with terror in its eyes.

 

The horror of high unemployment in the US has resulted in the Fed unleashing further quantitative easing. However, in a marked deviation from previous rounds of QE, this will be open-ended and not constrained in size. Initially, the Fed plans to buy $40bn of Mortgage Backed Securities (MBS) each month. The focus on Agency Backed MBS (government backed) as opposed to Treasuries is designed to reduce further the cost of mortgages and help stimulate the haunted housing market. The re-financing of existing mortgages at lower rates should also help free up disposable income, with the hope that consumers then proceed to spend.

Elsewhere other central banks, including those in the UK and Japan, have treated their economies to further money printing whilst Asian economies are cutting interest rates. This is a trick which has been played many times since the beginning of the global financial crisis, one that historically has been beneficial to both equity and credit markets. Indeed it is difficult to see that current market levels would be sustained without such support. How much higher we go from here is questionable.

Housing data in the US remains encouraging, whilst manufacturing surveys appear to have at least stabilised. The latest quarterly company results show earnings remaining solid but the all important revenue growth lagging expectations. It seems that companies lack confidence, preferring share buybacks to reinvestment, seeing the future as dominated in the short term by the US ‘fiscal cliff,’ which may yet prove to be the issue that dips the economy into recession.

The fireworks will begin on 6^th November, the day of the US Presidential Election. Current polls suggest that Obama will achieve a second term in the White House but that Congress will be Republican. If this occurs then we can probably expect a repeat of the thriller of last year’s debt ceiling debate, when a deal was reached close to midnight after much political brinksmanship. The Fed has gone further with monetary policy than any commentator would have dreamt. Its objective is to remove the lurking fear of uncertainty and restore confidence to support the politicians in fostering economic growth. A nightmare on Wall Street is that the fiscal cliff becomes a reality.