Markets across Asia and Europe followed a late sell-off in New York Feb. 20 after the Federal Reserve released comments hinting at an early end to its easy money policy. Weak economic data out of Europe further unsettled markets. Wall Street extended its losses in early Feb. 21 New York trading.
At the end of trading Feb. 20, the damage had been done, with the S&P down 19 points or 1.24 percent, closing at 1512. Earlier, the Federal Reserve had released minutes from its January meeting on monetary policy that showed some members of the Fed’s decision making body were concerned about continuing easy monetary policy.
“Several [members] expressed concern about the potential for excessive risk-taking and adverse consequences for financial stability,” the Fed minutes showed.
This stance differs from the previous language of the Fed. In January 2013, it had decided to keep on buying mortgage backed securities and government bonds at the rate of $85 billion per month. The purchases would be continued until the unemployment rate drops below 6.5 percent or inflation persistently stays above 2 percent.
At the time of the announcement on January 25, the decision was perceived to be carried by most members of the Federal Open Market Committee, the body that sets monetary policy. The minutes released Feb. 20 however say that “many participants also expressed some concerns about potential costs and risks arising from further asset purchases.” The market interpreted the statement as an indication that the Fed might stop easing earlier than anticipated.
Former secretary of the Treasury Robert Rubin had warned of the difficulty of unwinding the “unprecedented” monetary easing and its implications for the economy in a speech in January: “Now tightening is no longer a matter of a small balance sheet. [Fed Reserve Chair Ben Bernanke] has this vast balance sheet to turn around … It’s a very difficult thing to do. You want to invest accordingly. “
Fed Driver Behind Global Stock Rally
“Right now [Fed] is targeting unemployment by money printing and keeping rates very low. They are encouraging people to move money from the credit markets to more risky assets. That puts money in the stock market,” hedge fund manager John Paulson commented on the Fed announcement of unlimited easing in January. This stance had boosted the S&P to reach a five year high 1,530 in early New York trading Feb. 20.
The prospect of a reversal of this policy sent stocks reeling around the globe. The Shanghai Composite index lost the most at 3 percent, partially because China previously announced its own tightening of monetary policy and because the state said it intended to curb real estate speculation. The Japanese Nikkei lost 1.4 percent.
In Europe, the Eurostoxx is down 1.9 percent in late afternoon trading Feb. 21. Forward looking gauges of economic activity disappointed and added to the Fed worries.
The Markit Purchasing Manager Index (PMI) for the Eurozone fell to 47.3 in February from 48.6 in January, signaling continued economic contraction and reversing a previous uptrend. “New orders fell for the nineteenth month running, with the rate of decline gathering pace having eased to the weakest for 11 months in January,” says Markit’s release.
A deepening recession in Europe would disappoint people who bet on an end of the euro crisis. On the other hand, Citigroup thinks that the bad economic data could prompt another central bank to provide more easing: “PMI data shows underlying demand picture in Europe still weak and also still supportive of our view that European Central Bank will cut rates in the second quarter and second half of 2013,” the bank wrote in a note to clients.