Markets Surge As World Engages In Global Bailout
There was a time in recent history where Ben Bernanke once said that he would "...drop dollars from a helicopter" if necessary to keep the economy from going into a depression. Well, today, the remaining survivors of the global financial rout have coordinated an "all in" gamble to save the world from the next impending crisis.
We had discussed in the past that our recessionary call on the economy in the first half of 2012 was contingent upon whether or not further rounds of government stimulus were injected into the system. We also stated that we expected those to occur by the end of this year. Alas, we are not disappointed. This morning's announcement that the U.S. Federal Reserve, European Central Bank, Bank of Japan, Bank of England, Swiss National Bank and Bank of Canada will lower the rates on currency swaps as well as lower pricing on existing US Dollar swaps provides a massive liquidity canon for global financial system.
From the announcement: "[The Banks] are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity."
The Federal Reserve also made the following comments in relation to the U.S. "U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses."
A Dire Situation
While the markets are surging from the direct injections into the financial system, more on that in a moment, the important take away here is that the world is in FAR WORSE shape than has previously been discussed. These are emergency funding measures and are done in order to hopefully prevent the next liquidity crisis. With the banks in Europe already on the edge of failure a suspicion that a major bank on the brink of collapse spurred this action may not be too far from the truth. The fact that a globally coordinated intervention is occurring is no small matter.
It is unlikely that these short term efforts to boost liquidity to financial institutions will solve the longer term fiscal instability of the Euro region, however, it does potentially prevent a near term freeze in the liquidity markets as witnessed in 2008 with the collapse of Lehman. We have seen this exact same thing play out before with the last time that we had coordinated efforts by the central banks back in early September. While it provides a short term boost to the market for a few days ultimately the more dire global landscape took the markets down.
What To Expect
Today's announcement caught the markets completely flat footed this morning, which is exactly what was desired, and is now promulgating a short covering squeeze in all major asset classes from stocks to commodities. Whether or not the short covering rally can continue will be important to watch.
While the actions are supportive it is very difficult to say for how long because the world is still very much engaged in a deleveraging process that will, and must, continue. The drag from deleveraging on the economic system is something that liquidity injections can't cure but rather postpones. The deep funding problems due to the sovereign debt crisis will still have to be addressed but the issue to dollar liquidity has at least been temporarily resolved.
Very likely the European Central Bank will announce more actions at their next meeting on December 8th to address the collateral side of the equation in order to continue to try and stabilize the Eurozone.
The bottom line as of today is that the risk to the downside in the U.S. stock market has been reduced to further governmental intervention. Whether or not these interventions solve the longer term problems that face the economy and the markets both domestically and internationally remains to be seen - but as we know from past experience - when the market is flooded with liquidity the banks will flood it into the financial markets driving risk assets higher.
However, with that said, the market has broken above the resistance levels of the previous trading range that existed from July - September between 1120 and 1220 on the index. With the liquidity push into the market it is very likely that the markets will make another attempt at the "neck line" resistance level from the topping process that began in 2011.
We stated in this past weekend's newsletter that investors should look at raising cash at the 1200 level should the markets get there. However, with this global intervention our advice is to now "wait and see" what happens over the next few days. Sometimes inaction tends to be the best course of action when volatile events occur. We definitely do not advise chasing the rally until the squeeze on managers is complete. Today is also the end of the month so mutual funds need to window dress their portfolios which is providing additional buying impetus today.
One thing we want to watch closely is oil. WIth oil prices surging past $100 a barrel today the negative implications to the consumer driven economy through rises in inflationary pressures may be felt sooner rather than later.
Therefore, it will remain important, at least from a risk management perspective, that in the near term the "risk on" bet may work. However, for longer term investors it will be important to keep a watch on the global and domestic economies as the negative implications of massive liquidity boosts are generally felt in the pockets of consumers.