Markets count on central banks to take action

The Euro sculpture at the European Central Bank is photographed with long exposure and moving camera in Frankfurt, Germany, Jan. 1,2012. THE CANADIAN PRESS/AP, Michael Probst

TORONTO - Traders will be looking at central banks in the United States and Europe for action to bolster the American economic recovery and find a fix once and for all for the eurozone debt crisis.

Markets found lift late last week after European Central Bank president Mario Draghi vowed that the ECB would do whatever is necessary to protect the euro currency union.

Traders were further encouraged after German Chancellor Angela Merkel and French President Francois Hollande released a joint statement saying they will do anything they can to stop the 17 countries that use the euro from breaking up. They didn’t offer details.

And the Wall Street Journal reported mid-week that the Fed was set to move to take new steps to spur economic activity.

The ECB's Mario Draghi suggested that the central bank could intervene in markets to lower the borrowing rates of financially weak countries like Spain.

Markets had been depressed in recent weeks while the debt crisis settled on Spain with the country mired in recession and high unemployment while banks are stuck with billions of euros in bad loans resulting from a collapsed real estate sector. The government has been forced to pay ever higher yields to service its debt with yields spiking above 7.5 per cent, a level considered unsustainable in the long run, prior to Draghi's announcement.

"The (ECB) has been on the sidelines for a number of months, putting pressure on governments to fix their financial situation to find some political measures to (fix) unproductive economies in Spain and Italy," said Patrick Blais, managing director and portfolio manager at MFC Global Investment Management.

"But they reached a point where they have to step back, yields are too high, they’re unsustainable, and come back into the market and provide at the very least a floor or some support to the markets and bond markets especially and the possibility of refinancing is critical at this point."

However, markets have been told repeatedly over the last two years by European officials that a fix to the crisis was at hand, only to be disappointed at a lack of details.

Traders will be counting on the ECB to flesh out Draghi's commitment with details when the bank holds its next meeting on Thursday.

Meanwhile, hopes are high that the U.S. Federal Reserve will indicate it's ready to embark on another round of stimulus to support a weakening economy.

The latest sign of weakness showed up Friday when the U.S. Commerce Department reported that economic growth slowed during the second quarter to its lowest pace in a year. Gross domestic product rose 1.5 per cent, which was roughly in line with expectations. That's down from a revised two per cent gain in the first quarter.

Another sign of a slowing economy has been job creation, which last month came in at just 80,000. Expectations for July job creation are similarly modest at 100,000.

"This is an economy which is still largely driven by consumer spending so exports aren’t going to necessarily step up to a great degree and carry the burden of growth", said David Watt, chief economist for HSBC Bank Canada.

"So if you don’t have jobs, you’re going to struggle to have consumer spending. So the fed looks at this to say, look, there is a potential that this could become a structural issue that could weigh on growth, so they probably need to do more."

Some analysts say the Fed would want to wait longer in order to assess the strength of the economy, but Watt disagreed.

"I would be more convinced if jobs were like 150,000 or even 120,000 on average but they’re slipping back," he said.

"The job market at that pace is not going to draw people back into the labour market. That’s not going to start cutting the average duration of unemployment. You still got an average length of unemployment of about 40 weeks. I mean, that’s absolutely astonishing. You have to cut it in half to even get back to what used to be the worst during recessions."

There have been suggestions that the Fed could embark on another round of stimulus known as quantitative easing, which involves the central bank printing more money to buy up bonds.

But Watt said that the Fed has other levers it can pull.

"When they’re in a situation like this, and they’re not meeting their mandate (for full employment), they have to do something," he said.

"I’m sure they will come up with some creative measure to do it and some could very well dip into being de facto fiscal policy. And I’m sure that a number of people will be upset the Fed is going far beyond traditional monetary policy levers in order to take these actions."