Today’s floor talk indicated the market moved largely on new monetary stimulus from the European Central Bank (ECB). If the ECB dropped rates and left it at that, we would be seeing some profit taking and position reversals; however, the ECB didn’t just leave things there. There was a new, €400B loan facility and a pledge to do more (i.e. asset purchases) in the near future. The ECB is clearly not finished yet.
Monetary Policy Smörgåsbord:
- Refinancing rate cut 10 basis points to 0.15%
- Deposit facility rate cut 10 basis points to -0.10%
- Marginal lending facility cut 35 basis points to 0.40%
- €400 billion long-term refinancing operation maturing in four years (LTRO3)
- Suspending bond purchase sterilization of Securities Markets Program (SMP)
- Moving from discussion of asset purchases to planning phase and potential implementation
“We think it’s a significant package.” – Mario Draghi, ECB President
Indeed it is significant. The ECB is clearly moving full tilt in the direction of bolstering their economy by increasing liquidity and loan availability, which will also weaken their currency. The euro has fallen 3% since the last ECB meeting when Mario Draghi’s press conference clearly targeted discussion on the rising currency. I believe it will correct even more with further discussion on asset purchases, especially if some key technical levels are broken (1.35 on the Euro/dollar pair).
The initial reaction to the ECB’s policy decision was quickly reversed soon after by traders. The euro fell to test 1.35 on the euro/dollar pair. The dollar rose. European stocks were up. Finally, U.S. Treasury yields rose. Soon after the initial trades were made, these trends reversed.
Turning back to key financial activity today, the euro appears to be completing a bearish wedge formation, which implies there’s more downside from here to the euro. We tip-toed on a key support level for the euro/dollar pair near 1.35, so I believe we have a short-term rally in store for the euro (buy the rumor in May and sell the news today); however, with the ECB pledging to do more, especially in asset purchases now that the ECB has conceded rates are at the “lower bound”, it’s my technical opinion that the euro has more room to go before the ECB is done easing.
Long-term, that’s an issue for the U.S. dollar, especially as our central bank has already begun to remove accommodation by tapering its asset purchases. The U.S. dollar index stands to strengthen as the euro weakens. The euro is the single, most important weight in the dollar index at 57.6%.
Source: Bloomberg
The trade-weighted dollar index is more diversified with the Euro area being the second largest component (16.22%) and China the largest (20.81%) as of October 21, 2013. So even in the trade-weighted dollar index, the euro is a very important currency in relation to the dollar. For more information on weights in the trade-weighted dollar, see here.
U.S. Markets
In what was a flat day to start off in U.S. equities, news that hedge fund manager David Tepper's chief market concerns had been alleviated helped to spark a major rally (his comments are attributed to move the markets), especially in small-cap and momentum stocks. Recall, two weeks ago, David had said, “It’s nervous time” and don’t be “so freakin’ long” on May 15th. The S&P 500 has been up 11 of the last 14 trading days since. Sometimes it doesn’t pay to follow guru advice.
Today’s break in the Russell 2000 above 1142 confirmed a trend reversal on a short-term basis. Additionaly, the gap up on May 27th is looking like a breakaway gap, which tends to begin a major move in the direction of a trade. That it happened after the intermediate-trend reversed was a confirmation of the break in the March downtrend. This doesn’t alleviate that the Russell may be forming a long-term top until 1208 is breached and confirmed by a 1-3% breakout. I’m on the opposite side of the technical momentum debate. I believe the breakout to new highs in the industrials, transports, S&P 500, and the S&P 400 (mid-cap) can turn the technology and small-cap indices around. This economy hasn’t overheated yet, there’s spare capacity, inflation is low, monetary policy is still easy, valuations are still lower than prior highs in the market, fund flows show investors still don’t believe in the stock market, and real-time measures of corporate profits have yet to roll over (see story). All in all, the bull hasn’t finished yet.
Summary
So today, the market was hit with a “significant (stimulus) package” as Mario Draghi pointed out in his conference call. The rumors have been flying over the past month that a 1) rate cut was imminent (possibly into negative territory), 2) that we may see sterilization of the SMP removed, and 3) a new LTRO loan announcement. It was also anticipated that we might see an official announcement leading towards an eventual asset purchase program. The ECB decided to announce all of these measures at once. It’s the belief of many traders that by hitting all of the major tools available to the ECB, the markets got a bit more than was expected; however, this has come after a month of anticipation and some profit-taking was necessary in a rising dollar and falling euro-trade as well as in the rising European stock trade.
Despite the profit-taking today, I believe there is more to come to these trades after they catch their breath as there’s no possible way the market has already discounted an asset purchase program; because there has been no “real” discussion as to what that would look like. That’s still a catalyst that will need to play out because as Mario Draghi said in the conference, “Are we finished? The answer is no, we aren’t finished here.” It’s still a carrot that’s being dangled, but I believe the discussion period is transitioning to planning period.
I believe the U.S. market was hit with another catalyst today, being the short-term technical breakout in the Russell 2000 as well as bullish comments from hedge fund manager David Tepper who basically said: What I said two weeks ago, doesn’t apply any more. Party on bulls.
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