Sunday, October 12, 2014

Are equities in a dive? | Mario Draghi at the weekend IMF / World Bank meeting

We do not often write about equities here at OmiCronFX, but of course they do have a bearing on Foreign Exchange rates. Even if certain influential economists, including some that are members of the FOMC, do not regard equities as part of the “real economy” and therefore to be disregarded when monetary policy is being made, the fate of stocks on the world exchanges have to be noted.

Now the Standard and Poors 500 (S&P 500) share index in the US has fallen below its 200 Day Exponential Moving Average (EMA). This is the first time this has happened since early 2012. The Dow Jones index is behaving in a similar fashion, but it is the S&P that is watched by the really serious traders. Very tellingly, the last dip below the 200 Day EMA for the S&P was also around the time of the ending of QE2 in the US. Then QE3 started and the indices took off again.

At the end of 2013 the former Fed chief, Ben Bernanke, let it be known that so-called tapering of QE3 was about to begin. Equities reacted to the downside but recovered when it became apparent that the Fed was not quite sure about it all. Now they are. QE is coming to an end, once and for all, this month.

It has long been a belief in some circles that the bull run in equities was fuelled more by the availability of cheap money to institutions that QE provides, rather than fundamental valuations and earnings. PE ratios are elevated. Are we now seeing the inevitable consequences of the low interest rate money tap being tightened?

Mario Draghi at the IMF / World Bank meeting

Mario Draghi, President of the ECB, gave a press conference over the weekend to mark the end of the IMF/ World Bank meeting in Washington. He reiterated that current measures being taken by the ECB were aimed at increasing inflation, to close to but not above 2%. He stated that it was not the policy of the ECB to manage the Euro exchange rate. However, it is our belief that the measures being taken to increase inflation will have the effect of lowering the Euro. This is particularly true in light of the current US dollar surge and Mr Draghi did acknowledge that monetary policy in the Eurozone and that in other major economies were on “divergent paths”.

The ECB measures involve the purchase of covered bonds and Asset Backed Securities (ABSs) denominated in Euros, or in other words growing the ECB Balance Sheet. While stopping short of describing this as Quantitative Easing, he did point out that in the opinion of the Governing Council it was effectively the last shot left in the locker of the ECB in this regard.

He also talked about reform. When asked what this would look like In practice, he cited the example of people in certain areas of the Eurozone who, when wishing to open a shop, would be required to wait up to nine months to get permission to do so and then face a very high fee from the authorities for the privilege. This was a major disincentive to business. He did not say exactly where it is going on but it is an interesting example of the need for reform, as seen by the ECB.

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