Comment: Volatility still king in global economy

GLOBAL markets continued to be restless this week. Shares drifted steadily down as uncertainty continued over the intentions of the US Federal Reserve.

George Kerevan

Will it or won’t it ease back on the big monetary stimulus programme that has fuelled the rush into equities since last year?

What the Fed will actually do depends on US job numbers, because it is pledged to continue with the stimulus programme until unemployment falls below 6.5 per cent.

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The May figures were published yesterday. Despite 175,000 new jobs (much as predicted) the unemployment rate remains resolutely stuck, up marginally at 7.6 per cent.

Even that has been aided by a decline in the labour force participation rate by 0.4 points in the past 12 months. That outcome suggests the Fed will continue cranking out the electronic dollars.

However, the US economy remains tantalisingly poised between solid recovery and marking time. Paradoxically, a few months of good job figures over the summer could spark fresh fears that the Fed will start winding down its monetary intervention.

Prediction: don’t count on an end to volatility. We might even see a major equity market correction, as risk emigrates to the emerging economies in Asia.

Mario’s dragging his feet over following Fed

While the world’s eyes are focused on the Federal Reserve, spare a thought for the European Central Bank (ECB) where the game is also afoot. This week saw more dire news about the eurozone economy, leading the ECB to downgrade its growth forecast for 2013 to minus 0.6 per cent.

However neither this (nor the gyrations in the equity, bond and currency markets) stirred the ECB into Fed-style action. According to the ECB’s president, the Jesuit-educated Mario Draghi: “It is not enough to justify immediate action.”

This grand insouciance helped rattle the markets, sending the FTSE down 1.3 per cent and Germany’s DAX down 1.2 per cent. Yields on wobbly ten-year Spanish bond jumped 24 basis points - a sign the euro crisis is merely dormant.

Till now, Draghi has talked a very good game about doing “everything necessary” to stabilise eurobond markets. But talking is not the same thing as doing. The eurozone is in a seventh consecutive quarter of contraction yet Draghi insists a Japanese-style deflation is not on the cards.

The best explanation for his myopia (I hope) is that he is awaiting the outcome of next week’s ruling by Germany’s Constitutional Court on the legality of the ECB’s pledge to buy unlimited amounts of Italian and Spanish eurobonds, thus shoring up their price.

So far, the ECB has not actually had to do much buying because Draghi’s promise has been enough to keep the markets quiet. But a negative ruling from the Constitutional Court will scupper the whole policy.