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6/25/13 – Central Banks to Market: “We Are Still Behind You!”

Written by Brad McMillan, CFA®, CFP® | Jun 25, 2013 11:16:12 AM

The volatility continues, with another decline yesterday in stock markets worldwide. And yet, in the U.S. at least, after a large drop at the open, markets slowly recovered through most of the afternoon before slipping again at the close. For today, most markets are in the green, and U.S. market futures are up as I write this.

I would argue that this is all part of a normal adjustment process, but there’s no denying that the market turbulence has eased as central banks around the world have renewed their public commitment to support economies and markets. Yesterday, two Fed presidents were quoted as saying that monetary policy would continue to be stimulative. Richard Fisher, a hawk, and Narayana Kocherlakota, a dove, both emphasized that a Fed exit from the markets won’t be on the table any time soon. Because they represent both ideological wings of the Fed, and both will be voting members next year, their opinions carry weight—and should help to reassure the markets.

The People’s Bank of China also weighed in with support for its banking system and a statement that it would keep rates at a “reasonable” level—interpreted to mean that the central bank would not allow more turbulence in the Chinese banking system. Central bankers in Europe and the UK also weighed in, with the head of the Bank of England saying, “The idea we are about to return to normal levels of interest rates is premature.” Can’t get much more explicit than that, and the European Central Bank indicated the same. Both the Bank of England and ECB are, in fact, rumored to be more likely to increase stimulus measures than decrease them.

Rates are still creeping up overall this morning in U.S. trading, but they are showing more volatility to the downside. In premarket trading, the 10-year Treasury note was trading at yields below yesterday’s. While it continues to tick above and below yesterday’s close, there is at least a suggestion that the market may be beginning to settle.

At the end of the day, the Fed’s announcement actually didn’t change anything—it just signaled an eventual slow pullback when the economy had improved sufficiently, which was inevitable. The statements by Fisher and Kocherlakota were designed to emphasize that, and there are preliminary indicators that the message may be getting through. The action by the PBOC has also reassured markets that, even as central banks discuss pullbacks, they haven’t abandoned their role as economic stabilizers.

At the same time, while central banks emphasize that support will continue, the real economy in the U.S. continues to improve. House prices continue to rise at an increasing rate, durable and capital goods sales continue to grow, and employment continues to increase. Despite the effects of the federal spending sequester, which are peaking right around now, the real economy continues to be healthy.

More volatility in the financial markets is certainly likely, even probable, but the renewed public commitment to stimulus, combined with the continued growth of the real economy, suggests there’s no fundamental reason that it should be a systemic problem. We will continue to watch the situation closely, but, at this point, it looks like a normal correction.