GO
Loading...

Busch: Not Quite Irrational Exuberance

Wednesday, 6 May 2009 | 9:56 AM ET

The Federal Reserve met on April 29thand left interest rates unchanged. "Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower." This first sentence quickly encapsulated the mood of the markets and the optimism that is moving through the financial markets especially the stock market.

This mood has generated a stunning 36% or 241 point rally in the S&P 500 from the lows. The 3.3% surge on Monday after positive pending home sales and some hints that the US Treasury will not need any additional TARP money was indicative of the power of the move.

The momentum on the upside has been strong, extremely strong and it has to begin to worry policy makers. Why? Unlike the Obama administration when they first came into office, they don't want to over promise and under deliver when it comes to expectations.

Typically, the FOMC makes a decision on interest rates and then waits to see the market reaction to the decision. If the markets begin to do something that either surprises the Fed or move in a direction that the Fed feels is incorrect, then the members of the Federal Reserve go on the speech circuit and attempt to change those responses.

Yesterday, Federal Reserve chairman Ben Bernanke did his best to tamp down the hyperbolic "green shoot" mood of the equity markets. However, But, Even After, Nonetheless, Still, Although were used to offset every positive comment on the economy in the speech. For those of you who don't usually read his speeches, I would recommend you start as they are excellent. Here's the key quote: "An important caveat is that our forecast assumes continuing gradual repair of the financial system; a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall. I will provide a brief update on financial markets in a moment."

Also in a speech to the Business Law Institute yesterday, Minneapolis Federal Reserve President Stern warned on the "too-big-to-fail" of TBTF problem and on the economy. On TBTF: "...let me instead warn that proposals which purport to address TBTF but which fail to correct incentives are unlikely to succeed. In particular, proposals to “shrink” the largest financial institutions or to rely on heightened regulation and supervision of and increased capital for such institutions do not address the fundamental problem and must therefore be viewed as unlikely to effectively curb TBTF. On the economy: "Once the economic recovery begins, the pace of the expansion is likely to be subdued for a time...But with the passage of time—as we get into the middle of 2010 and beyond—I would expect to see a resumption of healthy growth."

Finally last night, San Francisco Federal Reserve President Janet Yellen in a speech expressed serious reservations on the bright future. "While output is at least showing potential for improvement going forward, recent news from the labor market is still very weak. The unemployment rate has risen by 1.7 percentage points over the past four months and, as bad as that is, I think it actually understates the true magnitude of the labor market deterioration.....The underemployment rate, a broad measure that adds individuals working part time for economic reasons to the unemployed, now stands at 14¼ percent."

All three made efforts to reduce the expectations and timing of a quick economic rebound. To me, these three did this because they are watching the rapid rise in equity values and are concerned that it will get too far ahead of reality.

________________________

v align="left">

Andrew Busch
Andrew Busch

</</p>

Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.

Featured