There has been a recovery in risk asset markets in the past month. But this is a suckers’s rally based on the expectation that the credit crunch might be over and that there will be no systemic financial failure.
For the April fools, the credit crisis is over. The US medicine will turn the economy by mid-year. The housing overhang is fast disappearing. Europe is fine. And who cares about Japan anyway – it has been in recession for a decade. As for Asia and other emerging markets, they continue to boom. So buy, buy, buy!
However, in my view markets are ignoring the impact of the ensuing economic recession that is hitting the US and will spread globally. That will feed back into an extension of the losses in credit markets and lower financial asset prices. So it won’t be over as quickly as the market expects.
The problem is compounded by the failure of the authorities to address the financial crisis in the right way. Cutting interest rates and providing huge dollops of liquidity does not solve the issues of solvency. Rather, it debases currencies, particularly the dollar (as the Federal Reserve is the main culprit).