Thursday, September 22, 2011

Operation Twist not impressive, fiscal stimulus needed

Fed announced yesterday that it would change the average maturity of its bond holdings towards longer term bonds. This is carried out by selling short term government bonds (2-3 years) and buying long term bonds (6-30 years). The idea of this operation is to lower long term yields thus making mortgages cheaper and stimulating economic growth through housing market. This isn't something that markets liked to hear, unfortunately. S&P500 was down more than 2% yesterday in addition to -3% already at pixel time. Not to mention DAX that is down more than 5% in trading today.

There has been a lot of talk of decreasing effect of more quantitative easing. Since yields are on record lows already the effect of manipulations performed by Fed have just marginal effect. The problem is not that long term yields are too high. Interest rates are near 0% already. The problem is economic outlook. Companies aren't investing as much as they used to hence not supporting employment, the future of individual persons is everything but certain. There's only so much that Fed can do about it. They have done everything they can.

Unfortunately Fed is one of few institutions that realizes the importance of financial markets in modern economy and their importance in supporting economic growth. Unfortunately Fed is also one of few institutions that is willing to act quick. What is needed today, is economic stimulus by fiscal expansion.

We need governments of the biggest countries to step in, initiate infrastructure projects thus directly subsidising employment. We need them to expand not contract. Even though we have a debt crisis in our hands we need to borrow (and grow) are way out of this mess. Governments tend to overspend during good times and underspend during bad times. This is not the fiscal policy we signed up for! That's the basic idea of fiscal policy - to level out economic cycles.

Debt crisis has to be handled by bold guarantees by central banks (for example unlimited purchase of government bonds) or by issuance of eurobonds for example (in the eurozone). Instead of this we are crossing our fingers and hoping that we will somehow get out of this mess, dealing with consequences.

Unfortunately things have to get really tough for this to happen. Stocks are cheap around the world. We need bold action by governments to get the stocks rising again. Watch out for these weekend meetings of countries. I wouldn't want to be short ahead of some bold plans when these would be announced at some point.

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