The great enthusiasm

Last week Ben Bernanke described his intention to make FOMC communications more clear:

In more normal times, when short-term policy rates are not constrained, I expect that balance sheet policies will be rarely used. By contrast, forward guidance and other forms of communication about policy can be valuable even when the zero lower bound is not relevant, and I expect to see increasing use of such tools in the future.

It looks to me like policy-makers are getting the lesson of Jedi economics. That, as we’ve seen in Australia all year, the jawbone is an immensely powerful tool and when price signals cease to matter, the intentions of policy-makers have exaggerated power.

I’m not sure it’s a coordinated effort exactly, but the last couple of weeks have seen a very distinct ramping up of rhetoric from the Obama Administration aimed at fixing Europe and housing. The Europeans have adopted a reinvigorated rhetoric of saving themselves. And the Fed has also been busy with lots of new ideas under consideration to target growth and especially housing, even as Operation Twist does nothing at all. It seems to have all begun coming out of the Washington IMF meeting.

The ‘great enthusiasm’ as we might call it has had some effect. Coupled with better data emanating from the US August slump, markets have seized the hope and poured on the rally. They have no longer had to fight the monetary or fiscal policy mandarins.

So how far can the great enthusiasm this take us? That depends.

Yesterday we got a real boost in China’s PMI data. We also got some good trade data out of Japan. As I wrote yesterday, that has set up hopes that a short term virtuous cycle is possible as China and US sustain one another.

That has clearly put a rocket commodities. Copper has gone wild, up 12% in two days. Oil went bananas last night, up 5%. Grains, wider metals you name it, it’s up in the commodities complex. Even the iron ore crash slowed to just a 0.5% drop, Shanghai rebar rebounded 4% and ore swaps reversed course, jumping  %.

However, the underlying global economy is not strong. Last evening’s composite (manufacturing and services) flash PMI out of the Eurozone  fell to 47.2, down from 49 in September:

The survey internals were the inverse of China’s yesterday, all deteriorating:

This was no surprise to MB readers and shows Europe sliding inexorably into recession. I will add that the Japan September trade bounce was driven in large part by a 14.3% surge in exports to Western Europe, which one can’t be at all confident about repeating.

Nonetheless, equities continued their rally, across the continent and in the US on the great enthusiasm for a European fix.

Like Delusional Economics, I am skeptical that a permanent fix is coming. But that is not the point at this juncture. What will determine the near course of this rally is how well the Europeans manage to present the next leg of their enthusiasm. Even if the likely outcome that the fix is insufficient at this point, this rally can continue if the Europeans surround the outcome with an ongoing plan for the plan. They must show an unremitting intention to fix the problem. Any sense of resting on laurels, and the rally is sunk.

As for the longer term, not much has changed in my view. If austerity remains a big feature of the European resolution, growth will be elusive. Same for the US. This is a bear market rally.

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Houses and Holes
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  1. Overnight Euro markets were flat all morning until the US opened and decided it was “Risk-awwwwwwn baby” and everything went ballistic. The DAX went particularly silly.

    It looks like PIIGs bond yields blew out again overnight, so the credit markets aren’t participating in the great enthusiasm.

    Perhaps the credit markets will follow when Euro situation is “solved” on Wednesday. Who knows.

  2. “It looks to me like policy-makers are getting the lesson of Jedi economics. That, as we’ve seen in Australia all year, the jawbone is an immensely powerful tool”

    ‘Samson once slew a thousand Philistines with the jawbone of an ass. It remains just as dangerous a weapon today’

    (I don’t know the original author)

  3. I know a lot of people who are getting very impatient – just dying for a sniff of even *neutral* news to serve as their excuse to get back into equity markets. Last time I sensed the same sentiment was April 2008, and we all know where that dead cat ended up.