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The effect of stimulus

‘Volatility is a natural part of markets, whereas highly accommodative monetary policy is not.’ This was my statement on Monday about the effect of monetary policies on markets – it acts as a volatility depressor.

ECB
Source: Bloomberg

With the mere speculation of stimulus from the ECB overnight, some very interesting stats emerged in global market. The S&P had its biggest daily rally in over a year and has also experienced its sharpest point advance since 2011. The European market had their strongest daily rally in 14 months. Since falling 9.8% from September 18 to the low on October 15, the S&P has now retraced 61.8% of that fall – meaning the next level to retrace on a technical level is the full 100%: 2019 points.

Some will point to US earnings season as the reason for the rally. 79% of companies (that have reported) have exceeded the highly pessimist estimates on the profit line (the historical average is 70%). 60% beat estimates on the revenue line.

However, I see the massive buying overnight stemming from investors’ eyes lighting up over the rumours that the ECB is expanding its balance sheet.

There are several ways the ECB can expand its balance sheet back to the 2012 levels as it looks to provide increased liquidity to Euro nations.

Presently, there is EUR 1.1 trillion of non-financial corporate debt on offer and EUR 7.9 trillion in financial corporate debt on issue from Eurozone citizens. That figure includes all forms of debt, including risker debt. Considering the ECB’s mandate of buying only top-rated, that leaves the ECB with the non-financial and bank-issued instruments, totalling EUR 3.6 trillion. That is 3.6 times bigger than the ECB’s announced trillion euros of covered bonds and asset-backed securities program.

Considering the weakness in Europe, the prospect of an increase is real as it looks to increase access to financing, and even more stimulus. Current rumours suggest the ECB has begun buying Italian covered bonds, and that is only going to expand to other nations.

I remain concerned about the full unwinding of QE because of the reaction to the rumours from Europe and the fact markets believe the package will be expanded. In what is being described as the ‘Bullard rally’, St Louis Fed president Jamie Bullard publicly announced the asset purchase program should remain. Equity rallies are going to be as volatile as the sell-offs.

Next week’s FOMC meeting will be crucial. We are now in the blackout period before next Wednesday’s meeting (Thursday morning for Asia). With his words the last we will hear before the meeting, any stimulus from the US, Europe and even possibly China will see the markets lapping up liquidity and piling into equities. Be very wary.

Ahead of the Australian open

The ASX has experienced a similarly meteoric trading rise, having recouped 203 points from the intraday low to the close of the market yesterday.  We’re currently calling the ASX 200 up 56 points to 5380, which would see the ASX back in the black for the year.

However, this would also bring key technical levels into play. 5400 (besides being a psychological level) is the 50% retracement level of the high-to-low of the recent market pullback. At 5425, the market would cross back above the 200-day moving average. All major industrial metals rose solidly overnight, and RIO and BHP had strong gains in London as well.

It would be remiss of me not to mention Australian CPI today. There is more and more speculation that the RBA, if it was to move, would look to cut rates. I believe it will not move in either direction for the foreseeable future. However, the CPI today is estimated to fall back to the lower end of the RBA’s comfort band at 2.3%.

I see rates remaining unchanged due to the RBA’s preference for using the trimmed mean CPI print, which is estimated to come in at 2.7% - falling, but still at the upper end of the comfort band. All eyes will be on the AUD at 11.30am AEDT.

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