Spooked investors in limbo as Fed cuts QE and China flounders
Investors finally got what they wanted last Wednesday as more clarification was provided on the Federal Reserve's plan for tapering asset purchases.
However, if the subsequent sharp falls in global indices are anything to go by, they were perhaps less impressed with what was actually said.
Bernanke indicated that the central bank would begin the easing of asset purchases this year, with a target of ending the quantitative easing programme by mid-2014.
The Fed then went further by saying that at this point, they expect the unemployment rate to be down to 7% and that by the time it is below 6.5%, they would look to start raising interest rates.
Significant emphasis was therefore placed on the extent of the programme's dependence on data. Bernanke has a record of being particularly guarded in his outlook for the direction of Fed policy and the detail of the statement came as a surprise for market participants – hence the strength of the market reaction that followed.
The collateral damage of US policy changes extends well beyond American shores. Emerging markets, and specifically their currencies, are at greatest risk from a rise in rates. Such a move would threaten to reverse the West to East (and North to South) capital flows of recent years.
That risk began being crystallised while Bernanke was still speaking, with the Mexican peso and Brazilian real falling very sharply – extending the losses which began when he first removed forward guidance on May 22.
Following the announcement from the Fed, there was further downward pressure on equity markets from Asian data as the HSBC China flash Purchasing Managers' Index (PMI) numbers came in below expectations. This underlined what has been a recent bout of underwhelming performance, at least in terms of economic data, from the world's second largest economy.
Financial conditions have continued to deteriorate, with interest rates in the Chinese interbank market having been volatile – while the risk of a credit crunch appears to have been acknowledged by the People's Bank of China as reports stated that liquidity was injected to bring these rates down.
In Europe, Thursday's PMIs provided a modest respite from the otherwise negative macro level news. Despite slightly disappointing German PMI numbers, Eurozone and French numbers both came in ahead of expectations, providing support for the case of a Eurozone cyclical recovery and the convergence of German and broader eurozone growth.
However, with the mood of the markets tending towards the pessimistic, the tentative rally on Friday unwound in the European afternoon session after the Greek Democratic Left resigned from the government in protest at the decision to shut down the state broadcaster.
Greek shares lost 6% on Friday afternoon and have lost 27% in just over a month. With the FTSE 100 having fallen over 11% below its previous high this year after Bernanke's comments, the impact of central banks on the movements of markets is clear.
As economic data continues to be mixed, the recent tough spell for equity markets looks likely to continue into the start of the summer.