It was all a dream
Investors are clearly upset, but it’s hard to know why. The chronology is clear. The rout in global markets – from U.S. Treasuries to copper, from Shanghai stocks to junk bonds – started after Ben Bernanke, the chairman of the U.S. Federal Reserve, suggested that the American economy might soon be strong enough to need less monetary support from the central bank. The causality is another matter.
One theory is that investors are trying to scare the Fed and other central bankers into changing their mind on negative real interest rates and the newly minted cash of quantitative easing. Like a herd of “feral hogs”, as the Dallas Fed’s Richard Fisher put it in the Financial Times, they could be testing the willpower of central banks.
Fisher says the Fed will stay tough, but it may have to retreat if another theory on investors’ reasoning is right. Bernanke may overestimate the strength of the U.S. recovery, and so underestimate what tighter money does to the economy. More expensive mortgages could upend the still-fragile American housing market, and a fall in bond prices could wreak havoc on the financial system.
There is one other explanation of the market ructions: a loss of confidence in the power and wisdom of central banks. Last year, it took only three words – “whatever it takes” – from the European Central Bank’s Mario Draghi to turn around the euro zone bond market. And at least until now, investors have shared Bernanke’s confidence that QE was effective, and not harmful.
But the Fed’s apparent willingness to withdraw QE while there are still question marks on the economy might be a sign that Bernanke has noticed that the ample flow of money distorts financial markets more than it encourages lending and spending. He might even be listening to critics from emerging markets, where much of the cheap funds land in the form of destabilising hot money.
All these explanations probably have some truth. As investors get ready for a QE-free world with less potent central banks, they will move in frightened – and frightening – herds.