Beginning of the end? Market jitters over stimulus programs

Article written by Eve Cook

The FTSE-100 dipped earlier this month to more realistic levels, but it took a further 3 per cent tumble on 20th June following the US Federal (Fed) Reserve’s indication that it plans to put the brakes on its stimulus program. Chairman Ben Bernanke said that due to the recovery of the US economy, the Fed will start to ease back its bond-buying program later this year, with a view to ending it mid next year. The Fed currently buys some £55 billion (US$85 billion) of US debt and mortgage-backed securities each month, which has sent stock prices up and borrowing rates down to record lows.

The news wasn’t unexpected: there has been plenty of volatility in the markets recently due to speculation about just such an announcement. Regardless, Mr Bernanke’s words gave investors a fresh case of the jitters. On Thursday (eds June 20^th) the FTSE-100 closed 189.31 points (3 per cent) lower at 6,159.51, a five-month low and its biggest daily drop since September 2011. The Dow Jones Industrial Average fell 206.04 points (1.4 per cent) to 15,112.19, the S&P 500 index slid 22.88 (1.4 per cent) to 1,628.93, and the Nasdaq composite index fell 38.98 (1.1 per cent) to 3,443.20. While the markets have since bounced back, they are likely to remain edgy for a while yet.

Bank of England divided over its approach

In the UK, the Bank of England (BoE) remains divided on the issue of stimulus programs. Earlier this month it acknowledged that market volatility was likely to continue, due to the uncertain direction of US monetary policy. Minutes of the BoE’s latest policy meeting showed members were split over whether the Bank should restart its own quantitative easing policy, with outgoing Governor Mervyn King outvoted in his bid to extend the £375 billion (US$580 billion) program. Mr King argued that although there are signs of a modest recovery in Britain, economic growth is still too slow and unemployment is too high.

The committee members who agree with Mr King’s position have pointed to eurozone risks and weak wage growth to make the case for further stimulus in the UK. Others feel that the market’s reaction to the Fed’s announcement on Thursday proves that such measures can be effective, but that they are  simply not needed at this point in time. Still others argue that the recent market volatility proves that the benefits of quantitative easing are dubious when compared to the overall cost. They also said it will be difficult to normalise monetary policy when these programs inevitably come to an end. For now, the committee has decided that recent economic developments have been consistent with the BoE’s forecast of a slow but sustained recovery this year, and have therefore vetoed any further stimulus measures.

Reasons for the (cautiously) positive economic outlook

Britain’s economy grew a stronger-than-expected 0.3 per cent in the first three months of the year. Last month, the British Chamber of Commerce revised its quarterly economic forecast upwards for the first time since the UK entered recession in 2008. It expects growth of 0.9 per cent in 2013 and 1.9 per cent in 2014 which is 0.2-0.3 percentage points higher than previously forecast.

British consumer sentiment hit a six-month high in May, putting it well ahead of the Eurozone where consumer confidence also increased, but only marginally. An example of this confidence appeared last week (eds Tues June 18^th) with the European Automobile Manufacturers Association reporting that while demand for new passenger cars had continued to fall in the Eurozone – dropping to a 20-year low in May – the UK had bucked the trend to post an increase in sales of 11 per cent. In the same vein, the UK Finance & Leasing Association also recently posted strong figures, with motor finance applications up in the first quarter by 22 per cent from the previous one. There is good news for car retailers however, the second quarter of 2013 should produce an overall rise in consumer spending as the post-Christmas hangover in the first quarter fades. According to Reuters, this should include the auto industry in Britain, which has been far more robust than across the channel. With the presence of Car Loan 4U and similar finance companies, consumers have had more confidence to upgrade or replace their existing vehicles. If sales do rise, this will be good news for the share values of companies in the auto industry. 

In the US, the economy grew at 2.4 per cent, slightly slower than the expected 2.5 per cent in the first quarter. Consumer confidence reached a six-year high in May, but slipped back in June. Steady gains in employment, rising equity prices and property values are promoting confidence. However it is clear that employment is going to remain a critical issue in the US. In its stimulus announcement, the Fed pointed out that “downside risks” to its outlook for the economy and job market had diminished, but Mr Bernanke emphasised that the strategy to wind back bond purchases was dependant on that trend continuing. He said that if the unemployment rate did not fall from its current level of 7.6 per cent to 7 per cent, the Fed might well hold steady on the stimulus program or possibly even increase it again. There’s no doubt that for the foreseeable future, all eyes will be on the Fed.