It’s an important question for the direction of markets. The attraction of further stimulus from the US Federal Reserve (or the European Central Bank) is obvious – in the short term it would overcome economic and liquidity concerns, and likely lead to an “easy trade” as all asset prices are boosted.
However, Chairman Bernanke has made it clear that the conditions for a third round of quantitative easing are NOT in place. The Fed would have a see a further “severe deterioration” in economic conditions, and the risks of deflation would have to outweigh the risks of inflation – clearly not the case in light of the most recent US CPI numbers, where the trend in core inflation remains upward.
Both Chairman Bernanke and ECB President Trichet called for a greater recognition by politicians that a fiscal response is required. Both indicated a need for government action to deal with debt issues without choking off fragile growth. Both re-iterated that the central banks alone cannot lift their respective economies out of slow growth. This appears to add a further condition before central banks will act.
Market action on Friday night was intriguing. US markets fell, the Dow touching a low point more than 200 points south. However, buyers moved in as participants focused on statement by Chairman Bernanke that despite a lower growth scenario the Fed is looking for modest increases in growth over the last half of this year.
The market response indicates it is moving away from a central bank “magic bullet” stimulus, and towards a less pessimistic outlook for the global economy. This view will be tested on Friday night, when we get readings on the ISM Index and non-farm payrolls in the US.