Despite widespread appreciation for the US Federal Reserve’s third round of quantitative easing, economists are not putting out the bunting just yet, as Joe McGrath discovers
Markets have been on a roller-coaster ride over the past three months, stimulated by central bank interventions, Asian GDP growth, European austerity measures and international unemployment.
Share prices were sent to artificially high levels by mid-September after the announcement of the European Central Bank’s Outright Market Transactions (OMT) programme and subsequent Federal Reserve statement on a third round of quantitative easing (QE3).
However, at the time of writing, most were expecting equities to ease back from their recent highs, given that the action witnessed through both QE3 and OMT have done little to resolve the actual crisis other than buy time.
Rumours that Spain was due to go cap in hand to finance ministers persisted throughout September after shocking figures released last month revealed that Spanish debt was now around 76 per cent of GDP.
This sizeable debt level would have been sufficient to score headlines alone as it is Spain’s highest ever, but economists’ predictions are not pretty, with some suggesting that plans to reduce its deficit to 2.8 per cent by 2014 are pure fiction.
The underlying problems in the US economy will need further work
Craig Erlam, market analyst for Alpari UK, is among those analysts predicting a worsening situation, especially for Spanish banks.
He says: “House prices fell 14.4 per cent in the second quarter from 2011, beating the 12.6 per cent drop suffered in the first quarter of 2012. This further undermines the Spanish banks, who have suffered heavily since the housing bubble burst, and recently required a bailout from the eurozone of up to €100 billion.”
Meanwhile, the German Constitutional Court ruled that Germany can legally back the European Stability Mechanism (ESM) bailout fund up to €190 billion, following some domestic discord in early-September.
Effectively, it meant that traders can now breathe a sigh of relief until December when a final court decision on the legality of the ESM and Fiscal Pact will be made.
Of course, this does not erase fears completely should the fund require a cash injection of more than the aforementioned €190 billion. This, analysts say, raised questions as to how the European Central Bank’s bond buying programme could remain unlimited while these parameters remain in place.
Alpari’s Mr Erlam says this should not be a problem in the shorter term, although it does leave the eurozone open to further problems should Spain or Italy require a full bailout.
“They have been criticised on numerous occasions in recent years for their slow reactions to the crisis which has potentially exacerbated the situation and this shows they clearly haven’t learnt their lesson,” he says.
“Passing laws to increase the bailout fund is by no means a quick or simple task, especially with tensions high in Germany towards the debtor countries. This condition just leaves the eurozone open potentially to creating further problems for themselves which could be easily avoided.”
Market volatility has not been limited to equities, however. As you would expect, currencies have been along for the ride too. The Federal Reserve’s QE3 announcement saw the US dollar sink against all other major currencies except the Japanese yen.
The underlying problems in the US economy will need further work, however, according to experts. Christopher Vecchio, currency analyst at Daily FX, is among them. He cites structural weakness in manufacturing due to declining competitiveness and unemployment as the two biggest issues requiring resolution in the US.
“There have been four out of five very disappointing labour market readings, as measured by non-farm payrolls, and US growth is barely moving higher at an annualised rate of 1.7 per cent,” he says.
“It’s clear that the conditions in which the Fed would need to rescind its end-all be-all QE programme are not going to be coming anytime soon.”