Don’t fight the Fed, what does Europe’s Recovery Fund have in store for the economy?

David Stevenson, 22/07/2020

Now the European Union looks to have followed the Federal Reserve’s lead in injecting liquidity into a COVID-stricken market with its European Rescue Package, the question of how to play this very strange situation is raised. Although the size of Europe’s package pales in comparison to the trillions of dollars the Fed has already injected into the US economy, what issues does large central bank interference in the market bring?

Dr Richard Smith (pictured) is a US-based economist and told Fundeye his views on the Fed’s actions. “The Federal Reserve doesn’t want to be seen as intervening in an election, this unprecedented liquidity is going to continue for another nine months. Once the liquidity is withdrawn, all bets are off. It’s been shown many times that it’s foolish to fight the Fed, pumping liquidity into the markets at all costs, they’re going to do all it takes to keep this thing afloat,” he said.

Dr Smith added that while the Fed may have had options it didn’t have any ‘easy options’. “Everything has become politicised, Ray Dalio [famed US hedge fund manager] recently came out and stated the obvious, that we don’t have free markets anymore, we have state run markets,” he continued.

Regarding where the alpha generating opportunities might be in this market, Dr Smith doesn’t pick an asset class or a particular sector, rather he says that opportunities arise in risk management, managing volatility and behavioural finance.

He mentions Daniel Kahneman and Richard Thaler, who both won the Nobel Prize for economics by pointing out that ‘people hate to lose’.

Daniel Kahneman got the Novel prize for essentially saying investors are risk seeking when they’re down and risk adverse when up. “This is something that asset managers really need to look at. Right now, if you’re still long the market, you’re really starting to sweat! You’re thinking ‘how much longer can this go on?’ We all know that markets can remain irrational longer than you can remain solvent, that idea dates back to John Maynard Keynes,” Dr Smith enthuses.

While many have argued that the presence of central banks in the market is irrational by nature, as these bodies aren’t looking to profit as most ‘rational’ players are, it looks like their presence is to be a feature for years to come.

Dr Smith said that given the pandemic, this current market cycle is likely to peak by the first half of next year, many commentators viewed the market to be late cycle before the outbreak of COVID-19 this year. With a second wave of the virus threatening, will economists have to get their red pens out once more if a pandemic strikes again?

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