Global Markets Brace for the End of Fed Stimulus

source: http://www.flickr.com/photos/alfmelin/

Source: http://www.flickr.com/photos/alfmelin/

“Recent confidence indicators based on survey data have shown some further improvement from low levels and tentatively confirm the expectation of a stabilisation in economic activity.”

Mario Draghi, president of the European Central Bank, said the above in a statement to the press on August 1. In effect, it suggests that if you’re an optimist, the European Union has just barely tripped into a recovery. News that flash estimates of second-quarter gross domestic product showed 0.3 percent growth in both the EA17 and EU27, the first positive action in six quarters, has in fact helped improve sentiment.

However, Draghi’s consistently middle-of-the-road comments leave room for pessimism, too. The growth experienced in the second quarter could very well just be a momentary reprieve, downwardly revised based on additional data or simply punctuated in a broader, full-year decline.

For its part, the ECB — or Draghi, at least — seems to believe that the economy will perform according to forecasts in the second half of the year. Those forecasts currently call for full-year economic contraction of 0.6 percent followed by 0.9 percent growth in 2014.

Despite overall growth, GDP in many major economies like Spain, Greece, and Italy continued to contract. Unemployment across the entire region remains high, at 12.1 percent, and enormous in hard-hit countries like Spain, which recorded a headline rate of 26.3 percent in June.

By most definitions, the situation in the EU is dire. Faced with crisis and howling economic headwinds, policymakers and central bankers, chiefly at the ECB, have engaged in monetary programs aimed at stimulating business activity. Like in the United States, benchmark interest rates have been pressed toward the zero bound, and an inflation rate target of 2 percent has been adopted. Draghi has publicly reiterated that the ECB’s “monetary policy stance will remain accommodative for as long as necessary.” Seeing that price pressures remain subdued amid ongoing depression, that could be a while.

This could be particularly true if signals from the currency market that suggest a reversal are correct. The euro has rallied over the past six months on optimism over the region’s recovery, but with the U.S. Federal Reserve gearing up to taper asset purchases, trading patterns suggest that the currency has topped out. One such indicator is the Bollinger band: The euro rose above the upper limit of its 20-day band on August 20, which could signal a change.

EUR-USD Currency Conversion Chart - Yahoo! Finance22

Europe and the euro aren’t the only ones facing pressure from the widely expected tapering announcement in September. Agitated by the specter of tapering, a swath of currencies led by the Indian rupee are being shunned by investors, and the dollar is looking more lucrative in the wake of weak economic conditions in much of the developing world.

The easy liquidity provided by the Fed’s program of quantitative easing has made its way into the nooks and crannies of the world market, and economies like Brazil, India, and others have been greatly appreciative of the liberal investments resulting from it. But that’s not going to last forever, and markets are getting shaky. Any move toward an end to easing has sent treasuries higher, increasing lending costs across the board and pushing investors away from emerging markets.

On Tuesday, China’s vice finance minister, Zhu Guangyao, said in a press briefing reported by Reuters, ”United States — the main currency issuing country — must consider the spill-over effect of its monetary policy, especially the opportunity and rhythm of its exit from the ultra-loose monetary policy.

Central bank Vice Governor Yi Gang, at the same briefing, added, “On monetary policy, the focal point (of the Group of 20) will be on how to minimize the external impact when major developed countries exit or gradually exit quantitative easing, especially causing volatile capital flows in emerging markets and putting pressures on emerging-market currencies.”

The G20 is scheduled to meet in St. Petersburg on September 5 and 6.

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