Yet again, the dovish FOMC statements have renewed growth concerns amongst the investors. In a press release on 10th of August, Fed policy makers highlighted that the pace at which the economy of United States was recovering has stalled in the recent months. The poor retail sales numbers, increase in unemployment data, depressed housing starts and the further contraction in the bank lending have unveiled the economic slowdown of the nation.

Deflation Concerns Weigh on U.S. Stocks

The statement spurred the negative sentiment amongst the traders, for the financial markets witnessed a massive pullback in equities following the press release. The sharp decline in the global risk appetite boosted the demand for Gold as the investors liquidated their funds from the risky assets and directed them to the safe haven asset. The decision of the central authority to maintain the Federal Funds rate at a low level of 0-0.25% for an extended period lent credence to the widespread deflation fears. In the context of price stability, the Federal Reserve stated that it will reinvest the principal payments from mortgage debt in the longer-term Treasury securities. While the continued commitment towards quantitative easing tells the tale of Fed making every possible attempt to restore confidence in the economy, there is a growing anticipation that U.S. may fall into the deflationary spiral. This is owing to the existent liquidity crunch and a run of bad data in the recent months.

Revisiting 1990s

Most of the investors are equating the current position of the world’s biggest economy to what happened with Japan in 1990s, the then super power. Similar to the prevailing asset bubble crash, Japan experienced a real estate bubble burst in 1989 following which the economy crashed and slipped in deflation. Post 1989, the liquidity conditions worsened and the central authority of Japan was forced to undertake several rounds of interest rate cuts to ease the money supply in the economy, reducing it to the lowest level of 0.1%. The mere return on the investment prompted investors to liquidate their funds from Japan and direct them to the other lucrative destinations. Consequentially, the Japanese Yen lost its appeal against its competitors and was reduced to the position of a carry-trade currency. So far, the Japanese economy has not been able to break-free from the clutches of deflation.

From the above it can be inferred that the current issues faced by the economy of United States are not new in nature and share a number of similarities with the economic condition of Japan, prevalent during 1990s. Therefore, in order to prevent the demise of another super power, the Federal Reserve requires going an extra mile in addressing the present problems. For if the economy of the United States slips into the Japanese shoes, the situation would get worse and we may experience another round of severe panic and unprecedented decline in the world’s financial markets.

Conclusion

While nobody can be certain about the futuristic views, for now we can only say that the choking recovery attempts of FOMC coupled with the deteriorating investor confidence lend credence to the general anticipation that the risk to the growth prospects of U.S. remain elevated and the downward pressure on equity markets is likely to be maintained until the release of a better and positive economic data.

 


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