Wednesday, November 30, 2011

The "perfect storm" of bullishness - or not

By Donald Sensing

By now everyone knows that market indices took off like bottle rockets this morning. The Dow, for example:

The reason is that the most important central banks in the world, including the US Fed, agreed to charge each other less interest in dollar swap lines beginning this coming Monday.
The U.S. Federal Reserve, the European Central Bank as well as the central banks of Canada, Britain, Japan and Switzerland agreed to lower the cost of existing dollar swap lines -- or reducing the cost of temporary dollar loans -- to banks by a half percentage point, starting December 5.

The central banks' actions was intended to ensure that starved European banks facing a credit crunch have enough funding as the euro zone's sovereign debt crisis worsens.

Also, China unexpectedly cut bank reserve requirements in hopes of boosting an economy running at its weakest pace since 2009.

Further encouraging investors, the latest economic data suggested the U.S. economy was moving more solidly toward recovery. The U.S. private sector added the most jobs in nearly a year in November, while business activity in the U.S. Midwest grew faster than expected in November surged.

Other data showed pending sales of existing U.S. homes surged in October by the most in nearly a year.

"There's a perfect storm of bullishness. PMI came out better than expected, plus what happened overseas, and ADP was well above consensus," said Donald Selkin, chief market strategist at National Securities in New York, with about $3 billion in assets under management.
It's true that the lates jobs report looks good. Even so, I think the surge will retreat - the move announced today has already weakened the dollar, resulting in higher prices of futures for oil, gold and silver, which are always priced internationally in dollars.

Furthermore, the other side of investment makers don't see what the big deal is:
S&P Equity Futures are up another 3 Percent, Bond Market Yawns

Global equities are sharply higher with this global coordinated action. S&P 500 futures are up another 3 percent and will gap higher.

Meanwhile Spanish 10-year bonds rallied (yields fell) a mere 7 basis points to 6.32%, Spanish 2-year bonds rallied a mere 8 basis points to 5.51%, Italian 10-year bonds rallied 10 basis points to 7.13%, and Italian 10-year bonds rallied 9 basis points to 7.00%.

Whatever the equity markets see, the bond market doesn't. A flight to safety of German bonds is back on, that China needs to cut reserve requirements is a huge sign of weakness (and no it will not stop a hard Chinese landing).

Also bear in mind that on September 15, there was coordinated swap-line action that did nothing.
Here is what happened to the ESI index after the September swap-line action:

The fact is that none of the underlying, weak fundamentals about the Eurozone's or America's economy have changed. The euro is as weak as ever and the dollar is weakening even more. Nothing about the PIIGS' situation is improved. So essentially, today's central banks' action place yet another temporary bandage on a suppurating wound. The markets are reacting to the news that something has been done, but by the beginning of next week, I think that the sane heads on Wall Street will understand that this something isn't amounting to much because basically, nothing has changed.

That's also the assessment of PIMCO's CEO, Mohamed El-Erian, who says that the indices moved so dramatically today because, "Risk markets love liquidity injections, real and perceived." Also,
First, these monetary institutions feel that, again, they have to move because other entities have continued to be too slow and too ineffective; and second, they feel that they cannot, and should not ignore an actual or anticipated need to relieve acute pressures within the banking system.

These two reasons were made even more pressing by last week’s dislocations in the functioning of European financial markets – most notably, the inversion of the Italian yield curve, pressure on government bond markets in core Europe, the growing fragility of the banking system, a drop in market liquidity, and growing hesitation by market participants to warehouse any risk.

The immediate impact on markets unambiguously favors risk assets across the world. The longer-term effect depends on the scale and scope of the follow through from others. This is particularly important as we count down to yet another European Summit on December 9.

The hope is that central banks are acting because, looking forward, they feel confident that other policymakers will finally catch up with a big and spreading debt crisis that has serious implications for growth, jobs and inequality. The fear is that they are acting because they feel that they must again pre-empt yet another set of potential disappointments.
The AP reports that all that happened today is that Europe has delayed "major debt decisions for 10 days." Will policymakers finally catch up to the markets and bankers? To think that is the triumph of hope over experience.

So: Near term: Party! Long term: Head for the hills!

Update, 1:45 p.m.: I predict that there will be a distinct pullback in the Dow by the time the NYSE closes at 4 p.m. today. At Close: Well, I called that the wrong way. The Dow actually closed at 12,029.56, up just under 474 points for the day. Things to look for: Yields on 10-year Italian bonds and the US Dollar Index. If the former drops about a point and the latter rises another three points or so, then the strong market indices will have a longer shelf life because together they will indicate that some sort of real response to the Eurozone's long-term issues has been adopted. But that is pretty problematical.

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