Did the Fed save Europe last week? No. But it certainly grabbed the headlines.
In an attempt to shore up confidence in Europe’s banking system and avert a Lehman’s-style meltdown at a sovereign level, the US Federal Reserve cut a deal with five fellow central banks. For more details on the mechanics of this, see my latest video: Has the Fed saved Europe?
Markets reacted to the news with something approaching euphoria: stocks rose and the euro put on a surge as investors hoped that America was riding to the rescue. But don’t be fooled.
Yes, by increasing dollar-funding lines to the European Central Bank in particular, the Fed ensured that a major banking disaster is unlikely in the short term. And the mere fact it is now involved in Europe and knocking heads together is some cause for cheer. But there are plenty of reasons to assume any respite for the euro will be short lived.
As Zoe Fiddes at easy-forex.com notes, “one US presidential candidate suggested that the central bank action was like giving more drugs to an addict: it feels good for a while but doesn’t solve the addiction problem”. European banks are still sitting on huge euro assets of largely unknown value. The solvency problem hasn’t been resolved, even if liquidity has been given a short-term boost.
Meanwhile, the central bank action that was announced stopped well short of a concerted debt-buying program along the lines of US and UK quantitative easing. The fact that the Central Bank of China also decided to lower its reserve ratio (this influences the amount of credit a commercial bank can create) suggests, says Fides, “that China is also more worried about potential fallout from the EU crisis”.
So for spread betters who wonder whether the rise in the euro and the fall in the US dollar seen last week are temporary, the message is – very much so. Sure, there’ll be volatility in the US dollar and euro rates, but given the state of Europe, I’d bet on the greenback to retain safer haven status.