Coordinated Central Bank Intervention Creates Short Covering Rally
The real title should be "The U.S. Fed Bails Out Europe". Overnight the major central banks around the world decided to cooperate to offer three-month U.S. dollar loans to commercial banks in order to prevent money markets from freezing up because of Europe's sovereign debt crisis. The European Central Bank said it would hold three fixed-rate operations between October and December to offer banks as many dollars as they needed, in order to ease any funding crunch in the year-end period.
Hmmm...yes...everything seems to be just fine in Europe so move along; nothing to see here.
That is just between them....right? Wrong. The Federal Reserve maintains dollar swap lines with the ECB and other central banks in order to ensure that they can obtain additional supplies of dollars when needed. Where do the dollars come from when these banks need them? Magically, of course, it is simply an electronic entry in the register and bingo - a few billion bucks created to solve the issue. If it were only so easy at home.
This international stimulus, bailout, "caught between a rock and a hard place" plan, does ease concerns temporarily about a Lehman type event which in turn is sending players that were short the market scrambling for cover. This is pushing stocks higher today within a well-defined trading range as indicated in our chart.
The market is trying to clear the 1200 level which has been a real problem since August but the daily charts suggest a short term rally to the 1230 area. This is where the upward sloping trading range (which is bullish by the way) collides with the negatively sloping 50 day moving average. Most likely this will be the end of the current rally as we are already approaching daily overbought conditions as indicated by the RSI chart.
Next week the Fed Reserve meets to discuss QE 3, Operation "Twist", and a variety of other options to try and support the markets and boost employment while keeping inflation down. Operation "Twist" is a program to remove inventory of 10 year Treasury Bonds from market to bring down interest rates. With interest rates at 2% already I am not exactly sure how successful this will be. Furthermore, if you can't get people to borrow at 2% I am not so sure they will come flooding through the doors at 1%. The Fed has also been very quick to say that all is well at the moment because inflation is benign. Well, maybe not since inflation just pushed through the upper end of their range of 3% today.
We will have to analyze carefully whatever type of plan they come through with in order to evaluate the potential impact on the markets. There is no reason to get too aggressive here but if you are short term trader you have a window of opportunity for a tradable rally into next week. For investors and 401k plans...just sit tight and wait for a clearer buying opportunity where reward outweighs the risk.