Markets Rejoice But Uncertainties Remain

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It was pretty much baked in the cake that the economy is slowing so rapidly that the Federal Reserve will have to come to the rescue, possibly as soon as its FOMC meeting next week.

But not so fast.

Friday morning the Commerce Department released the nervously awaited 2nd quarter GDP report. It was expected to show that economic growth, which slowed from 3.0% in the 4th quarter to 1.9% in the 1st quarter, had slowed to 1.3% in the 2nd quarter.

But second quarter GDP slowed only to 1.5%, and the first quarter was revised up from the previously reported 1.9% to 2.0%, while the 4th quarter was revised up significantly, from the previously reported 3.0% to 4.1% growth.

At the same time, the Bureau of Economic Analysis released its annual revision of prior years of GDP growth. The revisions take place each year as later data, like corporate tax returns, becomes available. They showed that 2009, the last year of the 2008-2009 recession, was not quite as negative as previously thought. The BEA revised GDP for 2009 to minus 3.1% instead of the previously reported minus 3.5%. It also revised GDP growth in 2010 and 2011upward, indicating the recovery has been somewhat stronger than previously thought. It revised 2010 growth to +3.0% instead of the previously reported +2.4%, and 2011 to +1.8% from the previously reported +1.7%.  

So although the recovery is the 2nd slowest from a recession in the post-war era, it has been somewhat stronger than previously thought, and the stumble in the first half of this year was not quite as severe as has been thought. That’s certainly good news.

But it lowers the odds that the Fed will feel the need to come to the rescue with more stimulus, the hope that has been a major driving force for the market in the face of continuing dismal economic reports, tumbling corporate earnings, and downbeat warnings from some of the world’s largest transportation and industrial companies.

Meanwhile in Europe, on Thursday the president of the European Central Bank triggered a big rally in global markets with just a few words. Taking the microphone at an investment conference he said, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me it will be enough.”

Global markets immediately took off in strong rallies, ignoring the addition of still more bad news in individual economic reports like home sales, business spending, and crumbling corporate earnings in Europe and the U.S.

The eurozone debt crisis has been weighing on global confidence for more than two years now. The statement immediately raised hopes that the ECB is preparing to undertake a QE2 type bond-buying program similar to that undertaken by the U.S. Fed in 2010, which served to at least temporarily re-stimulate the U.S. economy from its 2010 stumble.

But wait a minute! European officials have been making similar promises for two years.

Just three weeks ago the European Union emergency summit meeting not only promised to take significant action to control the crisis, but did so. But the confidence that created in markets was very temporary, with Greece soon back on the edge of the cliff, CitiGroup issuing a report this week saying the odds of Greece being dropped from the euro-zone have risen to 90%, and Spain’s borrowing costs rising to new record highs after only a few weeks of relief.

Cracks also quickly showed up in the promises ECB President Draghi made in his statement on Thursday.

On Friday, Germany, the largest and most influential member of the euro-zone, poured a degree of cold water on the hopes for more aggressive action by the ECB. Germany’s central bank, the Deutsche Bundesbank, again reiterated its opposition to further government bond purchases by the European Central Bank, of which it is a key member.

But Friday afternoon it was learned that ECB President Draghi will meet with Bundesbank officials next week in an effort to reach an agreement on major actions the ECB can undertake to keep Dragahi’s promise, and markets spiked up even higher.

In Europe, will the ECB really be able to deliver on its promise to do whatever it takes? It will apparently depend on Germany bending on its long-time opposition.

In the U.S., will the re-surging stock market and better than expected GDP report push off the Fed’s promise to come to the rescue “if needed”? Will markets continue to be able to keep the dismal 2nd quarter earnings reports, and continuation of disappointing 3rd quarter economic reports, pushed into the background?

After three straight days of sharp plunges, markets have now surged back for three straight days. Let’s hope their confidence is not misplaced this time.

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About Sy Harding

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