Active Central Bankers
While Mr. Bernanke did acknowledge that “we do have options that we can consider,” his testimony was disappointing to those expecting further quantitative easing. He did not signal any further easing. In terms of what easing measures would be considered favorable to the market, look toward mortgage-backed securities. Possibly targeting that market would close the dislocated gap between falling Treasury yields and private sector borrowing costs, which have not experienced a concurrent decline with Treasuries.
I remain consistent in my expectation that the effectiveness of further U.S. monetary easing is limited. Market appreciation will no longer be the consequence of Fed easing. The “reflation trade” was a market consequence of quantitative easing, but that was the strategy for 2010 and 2011 playbooks, not 2012.
Three regional headwinds challenge global capital markets – Europe, U.S., and China. Monetary easing will be most impactful in China, but more easing is needed from China. What ails Europe and the U.S. is the absence of fiscal solutions, not further monetary easing. Fiscal policy action is mandatory in order for the markets to hit the refresh button on the current correction.
Additionally, I remain more concerned about the potential U.S. economic slowdown than Europe. Capital outflows from Europe have been a known entity since the fall of 2011. The question is whether U.S. fundamentals have deteriorated to the point where capital inflows from Europe to the U.S. will cease. Our domestic market has been the recipient of capital from Europe throughout 2012. Are we still the “best house in a bad neighborhood?” is the ultimate question. The answer lies in the U.S. economic evidence.
Keep in mind, ahead of both the April and May U.S. Labor reports, the S&P 500® Index (SPX) was near four-year highs (Figure 1.1). It was those reports, not Europe, that initiated significant corrective selloffs.
Focus on the U.S. economic data….
Figure 1.1 S&P 500 Index (SPX) with pre-April and pre-May U.S. Labor report highs annotated