Don’t Fight the Fed

Debra Brown asks how I could post a warning for a Fall Surprise last week (a major market plunge), and then this week say that the market could be rising into the election — what changed?

Ms. Brown is right — I did shift slightly this week.  It’s based on the old adage — don’t fight the Fed. I had expected the US economy to shuffle along at a slow level, so that the Fed wouldn’t feel it had to act.  But the downward revision in the jobs numbers for June and July and the low number for August seem likely to prod the Fed into immediate action.  And if the Fed does act, that may push the stock market up for a couple of months, just enough to get to the election.   With Mario Draghi doing the same in Europe, with his plan to have the ECB engage in massive bond purchases for Europe’s troubled economies, the banks could pump up the markets for a while longer.

As I mentioned, none of this changes my view of the underlying global economy as fundamentally weak (new data from China this weekend on industrial growth further reinforced  the view of a slowing Chinese economy).  But the stock markets and the real economy, as we have seen many times, are only loosely coupled.  So they may move in opposite directions for long periods, depending on perceptions and policy.

If both the Fed and the ECB are going to take deliberate and dramatic action to boost the US and European economies in the coming weeks, then one has to expect the markets to move up for a couple of months as a direct consequence of that action.

That said, we will still likely see a major market correction sometime in late 2012 or in 2013.  Greece will run out of money in late October or early November, and may be cut loose from the Euro, with consequences that are difficult to foresee.  Whoever wins the US election, the “fiscal cliff” will affect confidence in the US and is unlikely to be resolved by the lame duck Congress, especially if the election is close or if Republicans do well in Congressional and Senate elections.  Markets still have not factored in fully major slowdowns in Brazil, India and China.

Of course, predictions are hazardous.  If Germany decides it has to save the Euro, and decides to encourage the ECB to support inflationary policies in the Euro zone, and if President Obama wins a major victory and can force through a resolution of the fiscal cliff problem by December, market optimism may yet prove vindicated.  Those events would justify today’s high levels and more.  I just wouldn’t bet on those events as the most likely outcome for this autumn.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
This entry was posted in The Global Economy, U.S. Politics. Bookmark the permalink.

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