READERS will be familiar of the idea of the “Goldilocks economy”, an idea that dates back to the 1990s. Just like baby bear’s porridge, such an economy will be not too hot (resulting in inflation) or too cold (resulting in recession) but “just right”.
Michael Hartnett of Bank of America Merrill Lynch has suggested the market may have been hit by a malign version of the syndrome, dubbing it Bad Goldilocks. Under this scenario
the economy is neither cold enough to provoke the quantitative easing that risk assets are so cravenly dependent upon nor hot enough to provoke losses in bonds that would inspire a wholesale rotation out of fixed income into equities and commodities
Indeed, one can trace the recent sell-off back to the March 13 Fed statement that seemed a little more upbeat about the economy, and thus damped hopes of QE. While equity markets are higher today, they have suffered a wobbly period since then. The US non-farm payrolls made things worse (although they might have revived hopes of QE) while the problems of Spain have revived worries about the European debt crisis. A lot of analysts are drawing comparisons with 2011, which also started well in market terms only to be hit by the Japanese tsunami and a spike in oil prices resulting from the Libyan civil war. Oil prices are still high but, thankfully, we have not had a repeat of Japan’s disaster (today’s earthquake off Indonesia so far seems much less damaging).
Ever since 2008, the problem has been that the economy (and thus the financial markets) has not been strong enough to stand on its own two feet but has been buttressed by remarkable levels of monetary and fiscal support. On the one hand, it seems mad to withdraw such support while the economy continues to be so weak; on the other hand, one wonders whether the economy will ever look strong enough to do without it.