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Kamis, 22 September 2011 | 02.52 | 0 Comments

Markets wake up to the horrible truth: the Fed can't save the world

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22 September, 2011
  • Markets wake up to the horrible truth: the Fed can’t save the world
  • Recommended article: Don’t ignore investment trust bargains
  • Yesterday’s close: FTSE 100 down 1.4% at 5,288... Gold down 1.18% to $1,782.35/oz... £/$ - 1.5500
From John Stepek, across the river from the City

Dear Golden Jann,

John Stepek I’m not sure what investors expected the Fed to do last night. I’m not sure they knew themselves. But whatever it was, they didn’t get it.

Ben Bernanke didn’t save the world.

It’s not as if the Fed did nothing. It committed itself to ‘Operation Twist’. We’ll explain the details below, but in some ways the move was even more aggressive than analysts had expected.

But stocks fell anyway. So what’s going on?


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Operation Twist left the market underwhelmed

Last night the Federal Reserve did pretty much what the pundits had expected it to do, and a little bit more. It launched ‘Operation Twist’ (so-called because they did something similar back in the ‘60s, when the ‘twist’ was the popular dance).

Here’s how it works. The Fed will sell $400bn worth of US government bonds (Treasuries) which mature in three years or less. They’ll use that money to buy $400bn worth of longer-dated Treasuries, those maturing in six to 30 years.

On top of that, they’ll use the proceeds of any maturing mortgage securities they hold (these are bonds backed by mortgages), to buy up further mortgage-related debt.

What’s the point? The point is that short-term interest rates are as low as they can go. The Fed wants to push down longer-term interest rates as well. All things being equal, this should make remortgaging cheaper in America, for anyone that can actually gain access to credit – which is a big if.

Now, markets are meant to price future events in. So given that the Fed only did what was expected, why the collapse? Confused analysts are blaming it on all sorts of things. Some say it was the Fed’s “gloomy view” of the economy that startled everyone. Others blamed the dive in Asian stocks on weaker-than-expected manufacturing data from China.

But the Fed hasn’t exactly been hiding its worries about the economy. And China has been at the back of investors’ minds for a while.

Investors are waking up to the truth about central banks

What’s the real problem?

I keep an eye on Twitter through the day (you can follow my musings and those of the rest of the MoneyWeek team if you’re on it – you can find us here). It’s handy for breaking news but it’s also interesting to read the chatter from traders.

It was very clear yesterday that most traders were reluctant to hold any big positions before the Fed meeting. Because they had no idea which way it would go.

In short, lots of people in the market yesterday thought that Ben Bernanke might pull a bazooka from his back pocket and somehow stun the markets with another flood of money or some brilliant new idea to prop up asset prices.

When he didn’t, that left a lot of disappointment, and a great big shorting opportunity. And that’s the real problem. Investors are starting to realise that there are limits to central bankers’ power.

From ‘house prices always go up’ to ‘a bet on the eurozone is a bet on Germany’, the financial crisis put paid to a lot of ‘sure things’. Now it looks as though the biggest, most dangerous myth of all – the Greenspan / Bernanke put – is on the verge of collapse.

Even the International Monetary Fund (IMF) – a lagging indicator if ever there was one – is waking up to the fact that loose money is the cause of our woes, not the cure. As Lex notes in the FT today, the IMF’s latest global financial stability report warns that we could already be facing a fresh credit problem.

This is the slowest economic recovery since 1929, says the IMF. “Yet it is the fastest rebound in credit.” Basically, with interest rates at rock-bottom levels, investors have “abandoned disciplined investing styles” and simply piled into “anything that pays a yield”. In short, “when capital is too cheap, it is mis-allocated”.

We’re heading for turbulent times

It’d be great news if the markets finally woke up to the poisonous effects of cheap money. Maybe we’d get back to valuing stocks, property and bonds on the basis of what they’re worth, rather than on the basis that central banks won’t let their prices fall.

Trouble is, investors might then also find out that most assets were worth a lot less than they’d thought. In the ensuing chaos, a lot of people would go bust. Banks on both sides of the Atlantic are already looking wobbly again. Another reason for the plunge in markets yesterday was the downgrading of three US banks by Moody’s. And the European situation isn’t getting any better.

Turbulent times lie ahead. In short, hang on to gold, be very picky when it comes to stocks, and avoid government bonds and banks. Looking at ways to profit from a stronger dollar isn’t a bad idea either – see my colleague David Stevenson’s recent MoneyWeek magazine cover story on this very topic: Will the US dollar rise from the dead?

Also – if you haven’t already checked out Simon Caufield’s presentation on his True Value newsletter, you should. Simon managed to shepherd his own wealth through the last crisis, making money in a year when most people lost it. It’s only open to new members until 4pm this afternoon though, so do check it out now.

Got a comment on this article? Leave a comment on the MoneyWeek website, here.

Until tomorrow,

John Stepek

Editor, MoneyWeek

Our recommended article for today...

Don’t ignore investment trust bargains
- When stock markets fall, it is often a good time to buy shares - and a good way to do this is via an investment trust. Tim Bennett explains how to find the best ones: Don’t ignore investment trust bargains.

And for yesterday’s market update, see below...


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Market update

Click here for the latest stock market news and charts.

The FTSE 100 slid back again yesterday as investors awaited the latest US plans to boost its flagging economy. The index closed down 1.4% at 5,288.

Miners saw the biggest falls. Antofagasta was the day's worst performing stock, down 6.9%. Rio Tinto lost 4.2% and BHP Billiton, Xstrata and Glencore fell between 3.9% and 3.4%.

Energy stocks were also out of favour. Cairn Energy, BP and Tullow Oil all fell 2.5%, and Royal Dutch Shell was 2.1% lower.

In Europe yesterday, the Paris CAC 40 fell 49 points to 2,835, and the German Xetra Dax was 138 points higher at 5,433.

In the US, the Dow Jones Industrial Average fell 2.5% to 11,124, the S&P 500 slipped 2.9% to 1,166, and the Nasdaq Composite was 2% lower at 2,538.

Overnight in Japan, the Nikkei 225 lost 2.1% to 8,560, and the broader Topix index was 1.7% lower at 744. In China, the Shanghai Composite fell 2.8% to 2,443 and the CSI 300 lost 3.1% to 2,685.

Brent spot was trading at $109.95 early today, and in New York, crude oil was at $83.90. Spot gold was trading at $1,773 an ounce, silver was at $39.23 and platinum was at $1,743.

In the forex markets this morning, sterling was trading against the US dollar at 1.5471 and against the euro at 1.1434. The dollar was trading at 0.7390 against the euro and 76.54 against the Japanese yen.

And in the UK, Easyjet raised its forecast for full year profits to between £240m and £250m, up from a forecast of between £200m and £230m it made in July. It also said it would return an extra £150m to investors in the form of a special dividend of 35p. The firm had already recommended a dividend of 9p a share.

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