Thursday, September 15, 2011

Coordinated Policy Action

Today brought news that five central banks – the Federal Reserve, European Central Bank, Bank of England, Bank of Japan, and Swiss National Bank – have teamed up to provide unlimited short-term U.S. dollar funding to troubled European banks. It was a coordinated policy response designed to calm increasing market concerns about another credit freeze, this time centered in the European banking system. The market reacted positively to the news, with stocks sharply higher globally, the euro rallied, and bonds were down.

While it remains to be seen how much of an impact this program will ultimately have, a strong, globally coordinated policy response is high on the list of “risks” to our current defensive investment stance.  For the past year, instead of global coordination, we’ve mostly seen ad hoc, unilateral attempts to combat structural economic problems from various countries and central banks. There has been little in the way of coordination, and somewhat predictably, most of the programs have enjoyed at best only fleeting success.

Today’s policy action is notable for its coordination, but seems designed mostly to address the growing liquidity crisis among European banks. It does nothing about solvency, which is the crux of the problem over there. However, if political leaders in Europe are ever able to put together something meaningful to tackle the solvency issue, while at the same time offering a globally coordinated monetary response, that could be a force powerful enough to spark another big rally in asset prices, and would likely cause us to abandon our current defensive positioning in order to participate. This particular program, while well received today, doesn't seem to be enough to do that on its own.