Kristina Hooper, CFP®, CAIA, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Mark Twain once observed famously, “History may not always repeat itself but it does rhyme.” Last week we saw another crisis-fueled selloff in Europe spreading to US stocks. And once again the Fed stepped in to calm jitters.
In late February, US investors went on an emotional roller-coaster ride. A comedian’s strong showing in Italy’s inconclusive elections caused angst in America, as fears grew over the impact of the anti-austerity candidate’s popularity on Italy and euro-zone stability. However, those concerns were short-lived. Delivering his semiannual testimony before Congress, Fed Chairman Ben Bernanke reassured investors that he did not see the Fed’s “easy-money” policies ending any time soon. He cited a weak jobs recovery and the vital role monetary policy has played in supporting a fragile economy. The stock market bounced back once investors got word that the spigot remained open.
Last week we saw a somewhat muted replay of that scenario. Early in the week, US investors sold off stocks as concerns over Cyprus permeated the market. Cyprus rejected a bailout from the European Central Bank (ECB) and the International Monetary Fund (IMF) because it included a tax on small bank deposits. It marked the first time that a financial rescue included a direct payment from citizens. (While euro-zone finance ministers have since struck a deal to avoid a collapse of Cyprus’ banking system and an exit from the euro zone, a deal was not in sight during trading hours last week.)
Shouldering the Load
Despite this threat to the stability of the euro zone, the Fed was able to mollify investors. The FOMC minutes showed the Fed will continue to help support the economy—and the stock market—by maintaining its current quantitative-easing program even though recent data suggest strides in housing and the labor market. At a press conference last week, Bernanke further explained that, going forward, the Fed may manage its asset-purchase program on a monthly basis by altering the amount of purchases it makes based on the latest economic data.
Tying asset purchases to economic outcomes is an important concept. It attempts to take the blunt instrument that is monetary policy and make it more of a surgical tool. The delicate recalibration of asset purchases according to economic indicators helps address concerns that the Fed will go too far in revving up the economy. It can take its foot off the gas pedal as needed. At the same time, it also addresses concerns that the Fed may retreat too quickly in the face of improving, but fleeting, economic conditions,
Investors were further reassured by the Fed’s projections for unemployment, which is not expected to fall below 6.5% until 2015. Its target strongly suggests that the Fed will hold the line on artificially low interest rates. Like Atlas strapping the world to his shoulders, the Fed is flexing its muscles to prop up the US economy. Yet, at the same time, the Fed is showing the gentle touch of a mother, cradling and soothing US investors when they get cranky.
Japan’s Bold New Target
In fact, the “central bank as savior” theme is becoming more common. The Bank of Japan, under its new head Haruhiko Kuroda, appears to be doing the same thing. Kuroda gave his first press conference last week, vowing to utilize monetary policy to successfully combat the deflation that has plagued Japan for the past two decades. Kuroda is confident that through monetary policy Japan can achieve the goal of 2% inflation within two years. And Japanese stock investors have clearly subscribed to the view that the central bank can help the economy. Since November 2012, when a new prime minister was elected and a change in monetary policy was anticipated, the Nikkei has jumped 42% at the same time the yen has fallen 16%.
While investors have roundly approved recent central-bank activism, some economists are more skeptical. Donald Brash, the former governor of the Reserve Bank of New Zealand, delivered a paper at Jackson Hole, Wyo. in August 1994 where he argued that monetary policy “is not a tool we should use directly to stimulate growth or employment” and that “the best contribution monetary policy can make to growth and employment is to maintain stability in the general level of prices.” His remarks suggest that the Bank of Japan’s efforts might be more successful than the Fed’s. However, in a speech last year at Jackson Hole, Bernanke argued that monetary policy can help lower unemployment—and that already has. The debate will certainly continue over which outcomes monetary policy can impact.
The Fed has conviction in its current monetary policy, which means financial repression will likely last for years to come.
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