You could be forgiven for missing the latest installment of market panic over the past ten days. It came and went like a summer thunderstorm -- passing over the global financial landscape quickly and violently. But unlike meteorological events that inflict actual harm, the sharp gyrations of financial markets have increasingly less relationship to real-world economies and exist in their own never-never land of self-fulfilling prophecies and conventional wisdom.
The proximate cause of the swoon was June's monthly statement from the Federal Reserve and Ben Bernanke's comments that the Fed might taper its purchases of bonds sooner than many market players had anticipated. The exact quote wasn't exactly dramatic (so few Fed quotes are!):
"The Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear."
The hint that the Fed would slow or even halt its monthly purchases of $85 billion of government and mortgage bonds was enough to send bond yields substantially higher and stocks substantially lower. It also made market bears substantially cockier. The most notable example was the ever-opinionated Rick Santelli on CNBC whose weekly rant took Bernanke to task not just for how he communicates, but for soft-pedaling the weak and tenuous U.S. and global financial system.
The bond market response was particularly dramatic. Yields on U.S. 10-year Treasuries went from just over 2 percent to 2.6 percent, still historically low but a substantial move in a short time. Emerging market bonds were even more eviscerated, and the ripple effects for pension funds and retirement accounts will be felt for some time as the value of supposedly safe bond holdings declined as much or more than supposedly riskier stocks.
There were other factors, including renewed concerns about China's credit situation, but in essence the gyrations in the markets reflect nothing other than the gyrations in the markets. An undue amount of the volatility stemmed from high-frequency traders (whose algorithms execute trades by the millisecond) and assorted speculators, as well as professional investors who have watched from the sidelines as stocks have gone up and have been waiting to make money from them going down.
In fact, many professionals in both the bond and stock markets have been convinced that the only reason that stocks and bonds and a host of financial instruments have been strong is because of easy money provided by both the Federal Reserve and by other central banks around the world. Former Fed chairman William McChesney Martin famously said in the mid-20th century that the role of the Fed and central banks was to provide enough money when times were tough and then "to take away the punch bowl just as the party gets going." That phrase has become the cliché of choice for investors. Throw a dart at any set of commentary from fund managers and traders over the past year, and that phrase or a variant occurs time and again. Type the words "Bernanke Fed punch bowl" into Google and you get tens of thousands of results.