The Global Economy in Turbulent Times

CHAPTER 45 ECB and Fed Clear Way to Act¹

August was a good month for stock markets despite “sell in May and go away”: US equity prices rose by 4 percent; European markets were up even more—6 percent, quite at odds with economic fundamentals. Traditionally, September marks the end of summer holidays, expecting to kick off activity to high gear. But the coming days and weeks will be bristling with events, including decision time for the Federal Reserve Bank (Fed) and the European Central Bank (ECB).

As I write, the ECB’s governing council is set to meet on September 6 to decide on details underlying its president’s statement last July that the euro was irreversible and the ECB is “ready to do whatever it takes to preserve the euro. And believe me, it will be enough,”² words which encouraged the latest rally. The euro rose more than 4 percent as investors gained confidence that ECB would rescue troubled eurozone economies, and would soon start buying Spanish and Italian bonds, where nations have seen borrowing costs rise to become unsustainable. At the same time, investors have also weighed in to possible bond buying (expecting more quantitative easing—QE3) by the Fed, ahead of its policy meeting, which concludes on September 13. In the event both central banks decide to ease, the euro–US dollar exchange rate would move to reflect which central bank is perceived in the market as more aggressive. This has already set the options market moving.

Weakness Dogs the World

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