After the Central Banks...

It has been a big week on the markets, dominated by two key policy meetings, at the ECB and the FOMC in the US. The simplistic analysis of the outcome of these meetings – looking at market reactions - is that the central banks have disappointed investors, who were expecting dramatic and immediate stimulus. I would argue that such an outcome was never likely, and that the central banks have acted very positively, setting the stage for a much more stable August than we experienced last year.

Few sincerely expected the FOMC to act on new quantitative easing, but some were disappointed that it didn’t change its statement to keep rates lower into 2015. Instead, the US rate-setters sent a clear signal that they plan to take more determined action in September, if the economy fails to improve until then. Most likely, FOMC Chairman Ben Bernanke will lay out his plans in more detail at Jackson Hole on 31 August.

The stakes were higher with the ECB, after Mario Draghi’s aggressive speech in London last week. In reflection, though, it is odd that investors were disappointed. The ECB was never likely to immediately and unconditionally intervene in bond markets; and market prices, although strengthened since London, were far from showing confidence that such a step would happen.

Few believed that immediate ECB action was really plausible, and with this in mind the announcement made – of a conditional plan being developed to provide massive support – was as much as we could hope for. There are some awkward nuances: Draghi believes markets are unfairly punishing European governments, but those same governments need to request a bailout to get his help, and Draghi is clearly seeking to bridge a period of planning and preparation with strong words. But, the key fact can’t be ignored: The ECB has put aggressive action on the table. This is a key development that we have been looking for a long time. Europe has been lacking a lender of last resort, the ECB is now preparing to fill that role.

The view is relatively positive then. Not to say that we see a sharp, long, structural bull market ahead. But, I am not especially surprised to see some disappointment in the markets, which tend toward excessive short-termism. There is still much to work through. But, I would argue that risky assets have found their bottom for the near term and should soon begin to work their way higher over the coming weeks.

Best regards,

James