The financial markets have returned to treating bad news as good and vice versa. The reason: they believe that bad news will force the Fed’s hand. Be afraid, be very afraid.

That news, which had been mixed for months, has turned decidedly bad. GDP numbers throughout the world signal deceleration. France’s economy came to a halt in the second quarter. A similar situation exists in Europe’s cornerstone economy Germany, where August economic growth was its slowest in more than two years. More foreboding, for the first time in two years, a key German new orders index contracted.

Most importantly, Canada’s economy contracted 0.1 percent in the second quarter. That was the slowest growth rate in … you guessed it, two years. Obviously, I jest about Canada’s importance but remember that they are our largest trading partner.

That brings us to the world’s current growth engine – Asia – where the news wasn’t any more encouraging. Manufacturing pulled back in South Korea and Taiwan with all-important China recording its second consecutive anemic number.

No need to review the details of our domestic growth. The first half has been far from stellar which begs the question: will consumers show second half resilience and pull us out of this “soft patch?” It’s very doubtful.

The debt-ceiling debate has left most with a bad taste. This, combined with seesawing markets, has contributed to plummeting consumer confidence. As reported by the Conference Board, consumer confidence dropped to 44.5 in August from a revised 59.2 in July. Guess what? It was the lowest reading in two years. Worse yet, the expectations index for the next six months also dropped precipitously.

And it’s not only Americans who are becoming increasingly pessimistic. Consumer confidence in the U.K. hit a four-month low in August. The last time the index has been so low was during the financial crisis of 2008-09. And euro-zone sentiment has turned equally sour. That region’s Economic Sentiment Index fell for a sixth straight month registering its weakest reading since May 2010.

Ordinarily, I don’t place much weight on consumer confidence data. It tends to be as fickle as a teenage fad. However, at the extremes – pervasive pessimism and all-encompassing euphoria – I’m more inclined to consider it relevant. It’s a simple case of momentum. Euphoria causes bubbles and pessimism tends to bring things to a grinding halt.

Ironically, the market rally, which recorded four consecutive up days, ended Thursday when a spate of good news was released. Last month’s consumer spending was surprisingly good, as were auto and overall retail sales.

And our ISM manufacturing index managed to stay positive, albeit marginally so.

Besides this obvious evidence that the financial markets consider the actual state of the economy inconsequential, a primary reason for the rally is the belief that the Federal Reserve will initiate another round of quantitative easing, or QE – this time with a twist. The markets need continued bad news to guarantee that the Fed steps in.

The Fed will act, but I’m uncertain whether it will be at its September meeting. Friday’s abysmal labor report has increased the probability, as there was a net gain of zero jobs in August. With downward revisions totaling 58,000 in June and July, in essence, the labor market lost ground.

The Fed minutes revealed that the committee was split 7-3 at the last meeting. That may sound like a substantial majority, but three dissenters is two-to-three more than usual. However, ultimately it’s the Chairman’s call, and I believe Bernanke is reticent.

In his comments following the Jackson Hole Symposium, Bernanke admitted that “the recovery from the crisis has been much less robust than we had hoped.”

You sure? Don’t want to take a bit more time to assess the situation?

Ben couldn’t resist citing transitory factors such as Japan and the run-up in commodity prices, but he did finally say “the incoming data suggest that other, more persistent factors also have been at work.”

Ya think?

You can’t make this stuff up. Bernanke is the head of the most powerful central bank in the world, and he’s just getting around to the notion that some of our problems might not be transitory.

But clearly that Harvard education wasn’t wasted on Mr. Bernanke. He figured out that in past recessions, housing – a.k.a. construction – was a major factor in reinvigorating economic growth. It’s shocking, but this time around, there wasn’t any pent-up demand to springboard us back to prosperity.

And it took this long to figure that out … because?

About halfway through his remarks came music to Wall Street’s ears when Bernanke said, “The Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.”

Jackpot. And so the markets wait for another round of inflationary QE that will artificially juice equities.

Keep in mind that Bernanke didn’t say he would act, but that’s immaterial. Just the reference to further action was enough.

I think Bernanke would rather avoid intervention, because he knows whatever he does will have only a marginal impact.

I believe his preference would be for Washington to do its job.

But if Washington continues its incompetent ways, he may have no choice.

Author, professor, entrepreneur, radio and TV commentator, Tony Paradiso can be reached at tparadiso@tds.net.

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