Why markets are panicking

In Financial competency on 12/02/2016 at 12:24 pm

They now assume that central banks don’t have a clue on how to save the world

What we are seeing, I think, are safe-haven flows. What is causing them, I believe, are central bank actions that undermine market confidence in the belief that central banks will do “whatever it takes”, in Mario Draghi’s phrase, to prevent economic collapse. The loss of faith is clearest in Europe, where Mr Draghi felt pressure to speak publicly on several occasions after the December meeting, in order to clarify that it did not represent a step in a less interventionist or more hawkish direction, and was not an indication of internal dissent over the course of policy. Crucially, those statements did not reverse the damage done by the December meeting. …

The Fed seems to have done something similar to its own standing, through the simple act of moving to tighten while both inflation and inflation expectations remained well below target. Just as Mr Draghi’s saying “whatever it takes” again cannot generate the same boost to confidence as it did the first time around, a simple reversal of the Fed’s December rate increase would not restore the market’s faith in the Fed to where it was a year ago. The Fed would need to do more, just as other central banks that raised rates away from zero prematurely found themselves subsequently cutting rates to levels below where they had stood before. Likewise, the Bank of Japan’s sudden pivot to negative rates raises the possibility that the central bank doesn’t actually know what it is doing.

Faith in central banks is of critical importance now because conventional policy is exhausted. To provide additional monetary stimulus, central banks can only turn to negative rates, to quantitative easing, or to jawboning of markets. It seems to me that, as a result of central-bank missteps, markets are losing confidence that central banks know what they’re doing, and are losing confidence that central banks are prepared to do what it takes to convince sceptical investors otherwise. Unless and until there are adequate demonstrations, it is possible this market panic will continue.

What is especially worrying is that not too much needs to go wrong in the real economy for things to begin breaking …

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