Commentaries

PMC Weekly Review - March 11, 2016

A Macro View: The ECB Speaks—Will Markets Heed?

While overall market volatility has receded since the intense bouts of selling in January and February, the past week has demonstrated that we are not yet out of those proverbial woods.

The most consequential news of the week was the much-anticipated announcement by the European Central Bank and its head Mario Draghi that the institution was committed to more aggressive measures: an extended period of both quantitative easing and negative interest rates. The goal of these policies is to combat what the ECB sees as a serious threat of European-wide deflation, which it hopes to accomplish by encouraging more borrowing and deploying more capital to spur economic activity in the Eurozone.

It remains to be seen how well these unconventional policies will work to rouse flagging demand. Japan has already been experimenting in similar fashion with, at best, mixed results, and the U.S. version of quantitative easing certainly bolstered financial markets but did little to increase wages or investment. It may be that the tools available to central banks, as expansive as those tools may be, are simply too limited in the absence of structural reforms that can only be accomplished by governments. We will see.

Financial markets, however, are quite sensitive to these moves, and yet do not know how to anticipate their effects. Hence the wild gyrations at the end of this week in both exchange rates and equity markets. Traders and algorithms, both of which tend to dominate trading flows these days, swung back and forth with lots of motion but little conviction about overall direction.

Add to this mix the escalating noise of an unusual American presidential election and you have a recipe for continued bouts of market volatility. For investors and advisers, however, that noise should not be confused with substantive change in the overall macro-economic and investing picture. U.S. companies other than energy and commodity-related names are in solid shape with very healthy balance sheets, and although American consumers may not be seeing much in terms of wage gains, they are certainly benefitting from lower energy prices and a general absence of inflation. These facts should remain in the forefront, even as they tend to fade to the background in the face of the daily noise and drama that unfolds in the world of economic policy and financial markets.

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