Thursday December 3

Stocks fall after Mario Draghi fails to unveil as much stimulus as was expected. The S&P500 and the Dow Jones each fell 1.4% to 2,049 and 17,478 respectively. Although Draghi in the past has made habit of delivering more stimulus than expectations, this time the market overpriced their anticipations. As a result the euro appreciated 3.2% against the dollar to $1.0954 after trading in the $1.06 range earlier in the day. The euro also rose against the yen and the pound by 3.3% and 1.9% respectively. German bund yields rose with the 10 year adding 19 basis points to 0.66% and the two year which had gone sharply negative in prior weeks rose 14 basis points to negative 0.30%. Peripheral yields rose significantly as well. Equities in Europe fell. As a result of the euro’s strength the dollar index lost 2.2% to 97.82. This is favorable for the Fed when raising rates as the dollar will not face as much upward pressure as had previously been anticipated. The US two year gained 2 basis points to 0.95% while the ten year yield gained 14 basis points to 2.32%.

Mario Draghi under-delivers at the ECB’s monetary policy meeting. The central bank announced that it will extend the duration of its monthly asset purchases by six months, so the program will now go until March 2017. Draghi also left open the possibility that this may still further be expanded. Similarly the deposit rate was cut by ten basis points to -0.3%. Lastly the asset purchases will now include municipal bonds in addition to government debt. Investors did not respond well to these developments in spite of the increase in stimulus. It’s possible that investors had been expecting and therefore pricing more drastic monetary easing measures. This may have included a larger cut to the deposit rate, a cut to the refinancing rate, as well as increasing the size of the monthly purchases which currently sits at e60bn each month. As a result of the mismatch between expectations and what was delivered in the markets, the euro and yields in the region reached a one month high. Analysts expect that Draghi may be trying to keep some tools for future use in the event that they become needed.

Janet Yellen refers to the effect of the strong US dollar on exports as it relates to tightening in a testimony to Congress. Once again she signalled her confidence in the US economy and the future outlook, and that a rate hike this month is likely. She acknowledged that the dollar is facing upward pressure as a result of monetary divergence with foreign countries, and how that will be a headwind to inflation and corporate outlook. The rate and magnitude of the dollar’s appreciation will in part dictate the steepness of the trajectory of interest rates.

Monetary policy divergence is set to have a distinct impact on the bond market. Over the past three decades bond markets have risen consistently as interest rates fell due to low inflation and quantitative easing pressures. Analysts are expecting inflation particularly in the US and interest rates to rise over the next year. However as rates abroad face downward pressure as a result of monetary policy there should be enough buying pressure in US fixed income markets to prevent yields from spiking up. There remains a great deal of uncertainty about this point, and as a result analysts expect that there will be volatility in markets next year.

Thursday December 3

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