Disastrous Fed Policy
September 25, 2012
A note on Europe
Bianco said that European central bankers are making the same bet by expanding their balance sheets. But Europe, he said, is stuck in a never-ending cycle of failed policies. European central bankers have responded to the crisis there by announcing aggressive measures; markets have reacted positively to those announcements, with lower borrowing rates; but those lower rates have caused central bankers to back off their policy commitments, which has restarted the cycle.
Europe will be in crisis for “the rest of our careers,” Bianco said. A resolution can come only from a fiscal union or from dissolving the euro and going back to legacy currencies. The former scenario is politically unlikely, he said, and the latter would be an “unmitigated disaster” for financial institutions.
One path that has promise is for economies to pursue austerity, something that Keynesian economists such as Paul Krugman have opposed. Ireland, Bianco said, endured 18 months of austerity beginning early last year. By cutting back painfully on government spending, it was able to lower its borrowing rate to the point that it may now be fiscally self-sufficient.
Implications for US markets
Markets for riskier assets are going to rally, Bianco said.
“They're going to rally at least through the spring,” he said. “They are going to rally on the basis of the Fed action, not necessarily on the basis of the economy getting better.”
Expect a steeper curve, higher interest rates and higher stock prices, Bianco said.
One potential threat investors should discount is the fiscal cliff, according to Bianco. He cited a number of surveys showing that the looming government spending cuts and tax increases were the biggest worry among fund managers. But other surveys show an overwhelming majority of fund managers expect broad fiscal reform in 2013. There is even a bill in Congress now – expected to pass – to extend deadlines for six months, he said.
“Nothing is going to happen on January 1,” he said.
The fiscal cliff has been over-hyped because the financial industry employs an army of consultants to help them understand Washington policy decisions. Those consultants have an incentive to identify some factor – perceived or real – to rally around, and it is now the fiscal cliff.
If you’re looking for one more positive signal from the market, it is the fact that the odds of Obama being reelected are now approximately two-to-one. Bianco said that, since 1992, there has been a near-perfect correlation between the S&P 500 and the popularity of the incumbent president, regardless of party.
“Obama is a risk-on asset,” Bianco said.
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