Tuesday, March 1, 2011

The power of words

The ISM index came out today with levels at 61.40, the highest since May 2004 and match the highest levels since 1983. The employment index is above 60 for only the third time in the last decade, yet the market is lower.

The problem for markets has been the power of words by central banks. Whether the Fed or the ECB, comments from central bankers have been driving the markets as much as any good news report with hard data. Currently, policy comments make the difference in market direction. The focus on news conferences is obvious. Markets react to the Q and A.

A question is whether this makes sense. Should policy be the driver of growth or should it be in the background? For central banks, the policy issue is not solely price stability, but whether central banks can bail-out governments and spur economic growth. In this environment, words will play a greater role.

The ECB is commenting that they may start to raise rates in the face of higher inflation. In itself, this should not cause a strong market reaction. The reason for the extra impact is that the ECB has been involved in many other issues concerning sovereign debt and fiscal balance; consequently, a rise in rates will not just have an impact on price stability but on the real economy.

We should be in an economic environment where words do not matter.

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