The Financial times article that hit the tape on Tuesday at 3:30 p.m. ET was enough to spark an amazing reversal day in which the Dow Jones Industrial average swung 378 points in the last half hour. The article, “EU examines bank rescue plan”, discussed a new focus by the European Financial Ministers to recapitalize the banks before the European Financial Stability Facility (EFSF) measures are passed. They have finally come to the conclusion that in the three months it has taken to get the July 21st measures passed to increase the EFSF, more banks are needing capital (not just U.S. dollars and liquidity) and the market is concerned EU officials are behind the ball on this one. One of the measures, besides increasing the size of the EFSF, is the ability to help recapitalize banks via loans to their home countries. EU officials have been waiting on the EFSF measures to pass before they take it on themselves to create a “bad bank” like the Federal Reserve did by itself in 2008 to take the bad debt off the balance sheets of banks. It looks like they’re finally taking the situation seriously. In the article, Olli Rehn, European Commissioner for Economic Affairs, tells the FT:
“There is an increasingly shared view that we need a concerted, coordinated approach in Europe while many of the elements are done in the member states,” Olli Rehn, European commissioner for economic affairs, told the Financial Times. “There is a sense of urgency among ministers and we need to move on.”
And
“Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty,” Mr Rehn said. “This should be regarded as an integral part of the EU’s comprehensive strategy to restore confidence and overcome the crisis”
The question is, “will this be enough to satisfy bond vigilantes?” If the recapitalization happens at the national level, that means we don’t need to spend another three months waiting for the 17 members to ratify a new bill. However, it raises new complications. Credit agencies may downgrade more sovereign countries (like Italy on Tuesday evening) if they feel the liability of contributing more cash to banks is becoming a burden. Despite these questions, investor response has been unanimous, as European and American equities have rallied strongly.
Merkel put the full support of Germany behind the issue by saying on Wednesday,
“Germany is prepared to move to recapitalize. We need criteria. We are under pressure of time and we need to make a decision quickly…If we need to discuss this at the summit (October 17th) then we are certainly ready to do that.”
Economic Catalysts
I think another catalyst that hit the tape in a big way was the oil inventory data yesterday. Shortly after the market opened on Wednesday, we got the Department of Energy report of a draw on inventories for crude, gasoline and distillates. A consensus was for a build on crude and gas. Instead of a build of 1.8 million barrels of oil, there was a draw of 4.7 million. If oil is the lifeblood of an economy, this report showed the economy wasn’t slowing down that fast. The S&P 500 rallied nearly 20 points in one hour after the news. In addition, the September ISM Services survey showed a better than expected reading of 53.0. Anything above 50 is growth. Finally, the ADP job data showed an increase of 91k private-sector jobs added in September. Last week’s drop in jobless claims, this week’s ISM manufacturing job data, and the ADP report point towards growth while the ISM services employment data pointed to weakness. Tomorrow's BLS report on September will be critical in extending gains we’ve seen in other economic indicators.
Thursday Central Bank Day
The market got two very big catalysts to sift through today with the Bank of England and the European Central Bank meeting. The BOE was more aggressive than planned with a 75 billion British Pounds quantitative easing package, 25 billion more than anticipated by the markets (275 billion in total). The ECB promised 40 billion euros on covered bonds next month in addition to offering banks two additional loans of 12 and 13-month durations. As I mentioned on FSN last week, I didn’t think the ECB would lower interest rates a month before Trichet relays the baton to the new president, Mario Draghi. And so the ECB left rates alone at 1.5%.
Despite the disappointment of leaving rates unchanged, the European market closed near its highs. In fact, the Euro Stoxx 50 Index closed above its 50-day moving average for the first time since early July.
Technical Take
From a technical analysis perspective, the whipsaw breakdown below 1120 that took place over Monday and Tuesday was a significant bullish short-term event. The reversal on Tuesday took place on high up-volume on the NYSE – the most I’ve seen since August 11th. In addition to the “bear trap” event, momentum has diverged from the August low relative to Monday’s closing low of 1098. The short-term bottom on Tuesday now has the makings of a possible intermediate-term bottom. Late Monday and early Tuesday morning, we removed our hedges in client portfolios. There are still a lot of red flags that need to turn green on this market for a meaningful rally to take place though. Trend, bonds, and the VIX are three of the culprits I’m following rather closely. The current levels are a major test for the Bulls.
Today’s close broke the short-term trend channel that began on September 20th. The next two are the July/August waterfall peak and the September rally trend (solid red lines) as well as the falling 50-day moving average (falling green line). A prediction on the market’s reaction to tomorrow’s BLS report has about the same chance as guessing heads on a quarter; however, the powerful resistance trends might rebuff the market from making any more short-term gains past 1180 (red circle below). We’ll just have to see.
