Talk about a triumph of “liquidity over adversity”, as Morgan Stanley puts it. Markets have shrugged off the inconclusive election in Italy and the Cyprus affair, which could have seen the island forced out of the eurozone. Chalk investors’ good mood up to central banks, says Julian Callow of Barclays Capital.
The US Federal Reserve’s unlimited money printing, and the European Central Bank’s promise to do “whatever it takes” to keep Europe together, have fuelled recovery hopes. Easy money also has a habit of leaking into asset markets.
But investors have become too used to expecting central banks to step in, says Pimco’s Mohamed El-Erian, and have neglected to ask whether all this intervention is actually working. If they did, they would soon see that five years after the crisis the world has yet to reach “escape velocity”, as the IMF puts it.
China’s small rebound seems to have faltered; European data have worsened; and while the US appears solid, investors may be underestimating the impending fiscal squeeze. Charles Dumas of Lombard Street Research expects a tightening worth 2.5% of GDP to knock at least 10% off the S&P 500.
“Financial markets can ignore weak data for a long time so long as it is not catastrophic,” says Albert Edwards of Société Générale. “But reality catches up with them eventually.” In the past two years, a strong start tapered off once the data weakened. Given the mismatch between the data and sentiment, the odds of a setback are rising.