Monday, 2 April 2012

A breather from Wall Street’s breadth – a pause that refreshes.

President Mario Monti. Image with permission: Presidenza della Repubblica
Equity markets are resisting any further re-rating. The LTRO (Long-term Refinancing Operation) rebound has taken them nearly back to where they were last summer before the Eurozone sovereign debt crisis intensified and spread to Italy and even to France, when it infected the banks. Italy’s Prime Minister, Mario Monti, may have been right when he recently said that the crisis in the Eurozone is ‘now almost over’. Certainly equity markets have been prepared to buy into the prospect. But only up to a point! And that point has been reached.

It’s not all been down to the LTROs though. Helping to support the firmer tone underlying the re-rating in equity markets has been the more solid look to the US recovery – and the Fed’s commitment to its super easy monetary policy. Doubts are growing over whether the Fed should remain so committed.

Mr Bernanke thinks it will take some doing still to ensure that the unemployment rate continues to drop to the Fed’s indicative 5 to 6 per cent objective it deems appropriate for the longer-term. Importantly the Fed Chairman also thinks the high rate of unemployment is nothing that more rapid economic growth cannot cure. The economy is just not growing fast enough. It is as simple as that, or as Okun’s Law, which he cited in a talk last week at the National Association for Business Economics Annual Conference.

Okun’s Law provides for an inverse relationship between the rate of unemployment rate and GDP growth. Specifically, to get the unemployment rate down requires the economy to grow faster than the rate of growth of potential output. As the US economy is a long way from growing anywhere near the rate of growth of potential output, The Chairman’s position is that the commitment to the Fed’s super easy monetary policy is perfectly justified. Tomorrow’s release of the March FOMC Minutes, will provide an insight into how widely shared this sentiment is. More >


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