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MAKE MONEY BLOG$~The Federal Reserve decided to sit on its hands on Wednesday, yielding the floor toMario Draghi and the ECB.
Chairman Ben Bernanke and his colleagues affirmed that they would extend Operation Twist until the end of the year, while pledging to keep rates at record-lows at least through 2014. While markets had gotten riled up on reports that the Fed might act preemptively, the focus now shifts to Europe, where Mario Draghi’s bold promises might clash with heavy resistance from Germany.
Buying itself time, the members of the FOMC decided to keep the monetary variables unchanged on Wednesday. Acknowledging that “economic activity decelerated somewhat in the first half of the year” and that “strains in global financial markets continue to pose significant downside risks to the economic outlook,” Bernanke & Co. checked their hand. Markets dropped a little, but weren’t too responsive. At the end of the day, the Fed stayed with its strategy. Acting on Wednesday’s meeting would have been “preemptive,” according to Barclays. Furthermore, the all-important jobs report, scheduled for Friday, is an important macroeconomic variable that the FOMC must take into account.
It should be clear by now that Bernanke’s Fed is an active one. A few weeks ago, reports released on two major news outlets suggested the Fed was seriously considering further action, including a third round of quantitative easing, or QE3.
Evidence that a third round of QE will be supportive of the economy is limited, though. While the first round of asset purchases helped stabilize the financial system, QE2 allowed the Fed to fight deflation, but only had a temporary effect. According to Barclays, a third program of quantitative easing would have limited effect on domestic demand, while at the same time feeding higher commodity prices. Furthermore, it would weaken the U.S. dollar and put upward pressure on the euro, hurting Europe’s beleaguered periphery.
Markets will now focus on Thursday’s ECB meeting. Mario Draghi, head of the European Central Bank, sparked a global risk asset rally last week when he noted he stood ready to do whatever it takes to keep the Eurozone intact; “believe me, it will be enough,” capped off a bold Draghi. It is now expected that the ECB will unleash a “multi-pronged approach” that will target rapidly escalating Spanish and Italian bond yields.
Specifically, it has been suggested that Draghi will rehash the securities markets program, or SMP, which allows the ECB to buy sovereign bonds on secondary market. Speculation that Draghi will push to get the EFSF and the ESM to help lower peripheral buying costs by purchasing Italian and Spanish bonds on primary markets has been tempered by heavy resistance from German politicians.
But Draghi may have set himself up to disappoint markets. According to Hartmut Grossmann, a regulatory expert working for ICS Risk Advisors, the regulatory framework is not in place for the ECB to “unveil a bazooka” at tomorrow’s meeting. In order to do so, the pernicious issue of a banking license for the ESM, the coming emergency fund, is needed. But resistance has been heavy, with German Finance Minister Wolfgang Schaulbe rejecting that notion. Furthermore, the German constitutional court must rule on the ESM on September 12, and a banking regulator for the EU hasn’t been established as of yet.
“In this market, people are looking for the big one-time solution that will break the back of panic and speculation,” Grossmann told Forbes, “but it can’t happen until the institutional framework is in place.”
Markets, which had rallied into this policy-heavy week, fell after Bernanke and the FOMC didn’t deliver further monetary easing. Yields on 10-year Treasuries fell to 1.521%, while gold dropped to $1,601.80 an ounce. Shares in major U.S. banks like JPMorgan Chase, Citi, Morgan Stanley, and Bank of America all slid after the release.
SUORCE: FORBES.COM
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