Wed 11/30/11 1:39 PM – Why Markets Jumped so Much Again Today

Wow! Twice in the last 3 days US markets have jumped 3.5% at the start of trading, following big jumps in Europe.

The first one was due to the most important EU leaders say they are working together to put in place tighter fiscal policy control over member nations, which really is the heart of the problem in Europe. Southern nations like Portugal, Greece and Italy have borrowed far more money than they could repay when markets started to price the debt lower and demand higher interest rates. Spain has not been quite so profligate but has a poor economy. Such tighter control will take either new EU treaties or substantial modifications to existing treaties which would take time.

While austerity measures in the south have met with much local protest they have made only small dents in debt or spending and austerity is depressing their economies. In short, they have acted irresponsibly in response to continual cries for more benefits from their constituents and have not acted enough like their more prudent northern neighbors like Germany, Finland and the Netherlands. Those countries have been loaning more money in order to try and bail out the southerners but now they want much more control over southern spending.

I hope the US is listening. It has been completely tone-deaf so far as witness the Super-Committee’s failure to find even $1 trillion to cut when the shortfall over the next 10 years is forecast to be $44 trillion.

The second (today’s) jump in the markets has to do with the fact that as bank assets are shrinking, banks are needing to hold more collateral against sovereign bonds formerly deemed risk-free, and banks around the world are pulling deposits and short-term loans to the European banks, central bankers around the world have decided to make massive amounts of dollars available to these European banks for a price half of what rates were yesterday.

You may remember that in 2008 there was a financial freeze-up when banks did not know whom to trust and suddenly refused to lend to each other. That brought business around the world to a screeching halt until the Fed stepped in. That freeze-up is what these central banks are trying to avoid this time.

Now, my take is that the second reason for the market jumps (the central bank news) is good but the first reason (gaining more control over southern European spending) is unlikely to actually come to pass in a meaningful and timely way. It is not enough to in the future give bigger consequences for spending too much; one must have actual direct control over how much is spent. That is very unlikely to happen. Whatever agreement comes out of the European leaders’ summit next week is liable to only partially achieve that end.

So, once again we have big announcements that goose the markets upward but that will likely prove to be too little too late as things unfold. Thus, barring future announcements like the Fed embarking once again on a quantitative easing program, I expect this rally will again fizzle in a few weeks as was the case last summer. Until then, enjoy the rally!