Last week we just couldn’t believe it. The economic news coming out of the US was truly shocking – on Wednesday we headlined, “Is this meltdown for Uncle Sam?” after a stream of economic news painted a picture of real woe.
Yet, what did the markets do while all this bad news was being announced? Well, in the US in particular, instead of making for the nearest tall building, and then preparing to jump, traders went out and celebrated.
For economics news, last Tuesday was something of a black Tuesday – yet the Dow leapt up by over 100 points, and that was on top of a 189 point rise the day before. In fact, by the close of day on Tuesday, the Dow had risen by 400 points in just three working days.
And why were markets so gleeful? Their reasoning went like this. With news that bad, the Fed has got to lower the rate of interest. Three cheers for bad news, it means cheaper borrowing.
In reality, the US has a massive dilemma. Inflation is at 4.2 per cent. Producer price inflation, which can provide a guide to future consumer inflation hit its highest level since 1981 and, of course, the price of oil and wheat are at new all-time highs.
Yet, the Fed is cutting the rate of interest so fast, that its economic scissors must be getting blunt from overuse. US rates have fallen from 5.25 per cent, back in September last year, to just 3 per cent at the time of writing. And now many are predicting further falls to follow, with some saying rates could fall to 2.5 per cent.
This means that the real rate of interest, that’s the rate set by the Fed minus the rate of inflation, is currently minus 1.2 per cent.
On face value, that means it pays to borrow money. You just borrow as much as you can, and let inflation erode the true value of the debt. It also means there is no point in saving, you would be better off spending your money as quickly as it comes in.
In reality, it is not that simple, because interest rates set by the markets are not keeping up with the Fed’s moves. In fact, it’s tempting to say the Fed action is meaningless.
In reality, banks need to attract savers, because they need more money in their electronic vaults to be able to lend out.
So what does the Fed have to do? Before he was chairman of the Fed, Ben Bernanke once made waves when he said the solution to a credit crisis was to scatter money from a helicopter. This earned him the nickname of Helicopter Ben; over the last few months he has been living up to his nickname.
Not literally, of course, but, as an example, on Friday the Fed announced plans to auction another $60bn. The banks won’t lend to each other, so the Fed is lending to them instead. Ben has, in effect, climbed into the metaphorical helicopter and dished out money.
The curious thing though is this. When the economic news was dire, markets soared. Then on Friday, after the Fed announced its latest plan to dish out more money, precisely the kind of thing you would have thought markets wanted, the Dow went into something of a nosedive.
For on Friday, the Dow fell 315 points. Now, there was time a when a fall of 300 points would have been one of the main stories on the national news. Not any more, last year the Dow fell by 300 points or more in one day on no less than five occasions. And it suffered another big fall in January of this year.
Even so, Friday’s fall of 315 points was still pretty dramatic. The Index is now back to the level before the big rises seen at the beginning of last week and the end of the week before.
And if nothing else, it shows just how irrational the markets are.
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