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Fed Rescue Will Come Deliberately Late!

  • Written by Syndicated Publisher 3 Comments3 Comments Comments
    May 3, 2012

    There can be no doubt anymore that the global economic recovery is in trouble again.

    In the U.S. we can see it in the reversals of previously positive economic reports; unexpected declines in durable goods orders, industrial production, new home sales, existing home sales, new home starts, construction spending, new jobs creation, personal income, consumer confidence, small business confidence, and so on.

    The Chicago Federal Reserve’s National Activity Index (CFNAI), designed to measure nationwide economic activity, was reported this week to have declined for the third straight month, dropping into negative territory in March.

    On Friday, the Commerce Department reported the U.S. economy already slowed considerably more than expected in the first quarter, with GDP growth slowing to just 2.2% from the third quarter’s 3.0%.

    In Europe, the 17-nation euro-zone has already slid back into recession.

    Meanwhile, the eurozone debt crisis has spread to Spain, the eurozone’s fourth largest economy, where in its recession unemployment has spiked up to 24.4%. On Friday, Standard & Poor’s downgraded Spain’s credit rating for the second time, citing worries about the country’s banking system. There are rising concerns that Spain’s government will not be able to meet its debt obligations and will have to seek a financial bailout, like Greece, Ireland, and Portugal before it. But due to its significantly larger size and larger debts, it would be much more difficult to rescue.

    This week the Dutch government collapsed, its president and his cabinet resigning after failure to reach agreement with the opposition on austerity measures to tackle its debt and deficit problems.

    Meanwhile, the United Kingdom, which is a major member of the European Union, but not a member of the euro-zone, announced this week that its economy contracted again in the first quarter, its second straight quarter of negative GDP, putting it officially in a recession.

    In Asia, China, the world’s second largest economy, has had to lower its slowing economic growth estimates three times in recent months, adding to analysts’ concerns that its economy may be coming in for a hard landing. China’s economy is dependent to a great extent on exports, and its current –account surplus was cut by more than half in the first quarter by weaker export growth.

    Also, in a surprise move on Wednesday, Standard & Poor’s cut its outlook for India, Asia’s third largest economy, from stable to negative, and restated its credit rating of BBB-minus, just one notch above junk. The credit-rating service cited its concerns about India’s ability to solve deep-seated problems that have clouded its economic outlook.

    The global economic recovery is obviously in trouble.

    So where is the Fed?

    In each of the last two years when the economic recovery stumbled the Federal Reserve came to the rescue with additional stimulus. And in his press conference on Wednesday, Fed Chairman Bernanke promised to come to the rescue again “if it becomes necessary”. Yet, at its FOMC meeting on Wednesday the Fed decided to do nothing for now.

    So what’s going on?

    The situation as I see it is that the Fed doesn’t want to repeat its mistakes of the past, of being so accommodative that  bubbles form (in stocks in 2000, and in real estate in 2006). So in an effort to make sure that neither the economy nor the stock market become over-heated, it prefers to let both the economy and stock market periodically slide back and cool off a bit before coming to their rescue at the last minute.

    At least that was its approach in each of the last two years.

    In each of those years, the Fed waited until worsening economic reports created fears that the economy was actually sliding back into recession, and the stock market was plunging in reaction, the S&P 500 down 15% (in 2010), and 20% last year, before it came to the rescue, with  QE2 in 2010, and Operation Twist last year.

    Waiting until the last minute, until the stock market was down double-digits, before providing more stimulus worked well both times, to keep the recovery going without causing either the economy or stock market to become over-heated. So why not again?

    Meanwhile, having seen it happen two years in a row, investors are confident they can rely on a similar rescue this year. So unlike the last two years when the market nose-dived when the economy began to stumble, this year the market is showing a remarkable ability to ignore the similar clear evidence that the recovery is in trouble again, perhaps even more trouble than last year.

    The potential problem with that, if the Fed indeed waits again until the stock market joins the economy in sliding back and cooling off a bit before it comes to the rescue, is the market’s confidence and resilience may delay the very rescue it’s depending on, until the economy’s rescue becomes more difficult.

    That is what happened with the eurozone’s recovery, as its central bankers waited each time for market declines to tell them they needed to take more action, and by then it was too late, and the crisis worsened.

    Just a thought.

    Images: Flickr (licence attribution)

    About The Author

    Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!


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