From Where Will the Crash Come?20. May 2013 by Joachim Goldberg
Germany’s benchmark DAX index has clambered to a new record high, but still some people are still convinced the financial markets are due for an almighty crash. However some of these doom-mongers are not newly pessimistic; they have, for instance, long since predicted a break-up of the eurozone. Indeed, supposedly, the crash and the break-up were inextricably linked together. I remember, as recently as two months ago, there was a suggestion the crisis in Cyprus could be the dangling thread that causes the whole fabric of the eurozone to unravel. As the world’s journalists outnumbered the clients in front of the locked doors of Nicosia’s banks, the talk was of a run not only on Cypriot banks, but on banks across the euro area. The whole zone could fall apart if parliamentarians refused to accept the terms of the rescue package.
The media proved to be exceptional purveyors of phoney drama, but when the crowds failed to drain the banks of the cash after the extended bank holiday the journalists simply went home. There was no bank run. Many bank clients had to withdraw money to make catch-up purchases (some people even showed up to deposit money), but there was obviously no newsworthy panic. In parliament, 29 of the 56 Cypriot lawmakers voted in favour of the plan to bail-in bank depositors. The approval took place on April 30th; since then I have search in vain for in-depth editorials on the outcome. Even without the recent drop in peripheral sovereign bond yields, the evidence that tensions in the eurozone have declined is clearly there.
Mercifully, for crash prophets, the eurozone is not the only source of concern. For instance, the US Federal Reserve is increasingly believed to be planning the imminent winding down of its QE policy. If policymakers begin reducing the volume of their monthly asset purchases, as has been mooted by the unofficial FOMC mouthpiece, Jon Hilsenrath, there might be an unwelcome reaction in the stock market. Even if the Fed tries to reduce its purchases gradually, by $10bn or $20bn per meeting, reckons Hilsenrath, investors would anyway take their cue from the very first decision and immediately price in all the others. The market reaction could nonetheless be brutal even if the steps are supposed to be harmless.
More fertile ground for the seeds of a crash is found at the ECB, as the central bank seems not only to have considered the possibility of negative deposit rates, but also to have prepared the technical framework. Ultra-low interest rates are already pushing investors and consumer into decisions they would not make in ‘normal’ times. Negative interest rates would further encourage the pursuit of yield into the darkest and dingiest corners of the capital market or simply force people to stuff cash under the mattress. In both cases, risk might be mispriced – precisely the situation the central bank used to warn about prior to the crisis.
While renewed financial market turmoil, if not a crash, is a possible product of official intervention by governments and central banks, investors on the lookout for catalysts need to be as wary of false-positives as of the real thing. So far, wrongly predicting a crash at every corner has been as costly as being roiled by the real thing.