Markets are stuck between tension and stress

It looks like US and European stock markets are headed for a few weeks of bad news to temper the effects of continued American money printing as part of quantitative easing. And that will affect our markets. 

In the US last week we saw a surge in markets after the Federal Reserve prolonged QE. But it is now apparent that a key driver of that stock market rally was short covering. Wall Street is now drifting lower partly because markets realise that at some time in the future QE will be halted and the longer it is prolonged the more difficult the unwinding process will be for markets. And while the interest rates on 10-year American bonds, which govern housing rates, at around 2.7 per cent are below the peak of 3 per cent, they are still way above the low of 1.56 per cent set earlier this year.

Meanwhile the main reason why QE is continuing is that the Congress enforced government spending cutbacks, which has restrained the US economy. And the new set of cutbacks come into force at the same time as the regular Congressional threat not to raise the debt ceiling.

Currently the Republicans want the Obamacare program extensively modified in exchange for lifting the debt ceiling – so there is a stand-off.

The opinion polls suggest that what the Republicans are doing is not popular, and with elections looming next year the issue will probably be resolved at the last minute but not before there is a lot of tension.

Over in Europe they have their own looming set of problems. When the German elections were concluded troubled countries appeared to sigh with relief and say: “Phew. Thank goodness the German election is over – now we can have a crisis.”

Now, of course I am jesting but all around the fringes of the European community, from Greece to Cyprus and even Spain and Italy, there are looming needs for new a bailout. And it’s important to remember if the countries don’t get rescued again their banks and the European banks who bought their government bonds as a yield play will be threatened.

But to date the word from Germany has been – keep the crisis lid well and truly closed. We must not have a crisis during the election campaign then maybe we will look after you. Accordingly Germans were not required to decide whether new amounts of their savings should be lost to more to bailouts.

European Bank shares are now much higher than two years ago and banks are able to raise capital to cover loses at a reasonable price, so the European economies have passed the worst. Now is the time to undertake ‘the rescue’.

If the required European bank recapitalisation is further delayed then the final blow-up will be much more severe.