By MarketWatch
NEW YORK (MarketWatch) -- Why would the Dow drop nearly 200 points after a Fed president, who votes on monetary policy, suddenly warns about deflation?
Trying to rationalize daily market reactions is bound to make anyone crazy, especially during typically slow summer days and especially in the current uncertain environment, when traders just try to get by without following a particular theme.
And it's been very tempting over the past month to forget the underlying economic risks ahead, with the market on track for big gains in July after corporate America reported earnings that could only mark a big improvement from last year's.
Reuters
St. Louis Federal Reserve Bank President James Bullard.
While signs of a worsening economic outlook have continued to pour in, they have only succeeded in temporarily bringing back stocks closer to what the economic reality really looks like.
The biggest financial and economic shock since the 1930s has left the U.S. economy operating far, far below its capacity and with 9.5% unemployment.
Economic stimulus that was too small to begin with is quickly fading and faces little chance of being extended amid nearly global hysteria about budget deficits. Many deficit hawks have also been crowing about the non-existent dangers of inflation.
On the face of it, the market should welcome St. Louis Fed Bank President James Bullard's late realization that deflation is the bigger threat and that the central bank should be ready to purchase more debt as the Fed's key interest rates can't move any lower. Read more on Bullard.
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But perhaps it's Bullard's sudden turn-around, without conceding that he's been plain wrong about sounding the alarm bells about inflation just a few months ago, that scared the market: This continues to reflect massive policy confusion both in public debates and apparently within the Fed as well.
The conservative line that budget deficits and inflation are always bad, even after a massive economic shock, is not only plain wrong, it's dangerous. Bullard, meanwhile, only cites vague academic calculations for his turn-around.
This could still have important implications for monetary policy, but it won't help shape the debate in Congress on how the government and the Fed should be doing a lot more to boost the economy.
Then again, Bullard's warning seemed quickly forgotten within a few hours. After the Dow's /quotes/comstock/10w!i:dji/delayed (DJIA 10,387, +46.32, +0.45%) initial swoon, the blue-chip average had regained most of its lost ground to recently trade only 25 points lower on the day.
Just another slow summer day in an uncertain environment.
-- Nick Godt
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