Friday March 11

Stocks rise and extend gains for the fourth consecutive week. The S&P500 rose 1.6% to 2,022 and the Dow Jones rose 1.3% to 17,213. The S&P500 rose 1.1%, and today’s gains bring the year to date losses to 1.1% and 1.2% for the S&P500 and the Dow Jones respectively. This comes as oil prices have stabilized, the US economy appears to be healthy, and concerns regarding China have taken a back seat. Brent prices today rose 0.9% to $40.39 and WTI added 1.9% to $38.55. In Europe, the German bund yield fell 3 basis points to 0.27%. Similarly the euro eased back slightly to $1.1150 however still higher on the week in response to Draghi’s comments yesterday. Yesterday Draghi indicated that the ECB would not cut rates further, which may be an attempt to ease pressure on the banking sector, and instead use other tools rather than interest rates to conduct monetary policy. The dollar rose 0.5% against the Japanese yen to Y113.74. The US 10 year yield gained 5 basis points to 1.98% and the two year yield rose 3 basis points to 0.96%. The market for fed funds futures now reflects a 51% chance that rates rise in June, which is up significantly from recent weeks in light of recent market trends and economic data.

In the aftermath of the policy misfire from the ECB yesterday, European corporate bonds appear to be the biggest winners. Bond prices for European credit rose across the board and CDS spreads dropped significantly reflecting a decreased chance of default. One source of concern regarding the newest implementation of QE is the possibility for the ECB’s buying to fuel a credit bubble. Buying pressure from the ECB may push down yields and increase demand for European corporate bonds, which would make it attractive for them to issue debt even when it may not be financially sustainable. The ECB is purchasing corporate bonds with the intention that making it easier for them to borrow will spur investment in the region and boost growth. Other concerns relate to liquidity conditions. If the ECB becomes a large holder in Eurozone corporate bonds, that essentially makes the market smaller and would make existing bonds less liquid. CDS spreads in the Eurozone fell to 68 basis points today which is down 25 basis points from before the announcement. High yield eurozone bonds have also rallied, as investors expect that the ECB’s buying of investment grade bonds will provide support to assets further down on the credit spectrum.

The PBoC sets the daily fix of the renminbi to the strongest level since early December. This move is related to the euros big gains yesterday in the aftermath of the ECB’s policy misfire. The euro gained against the dollar yesterday, and China is attempting to keep its currency even with large trade partners such as Japan and the Eurozone. Historically China has kept the renminbi pegged to the dollar, however in recent months China has sought to change this trend as the dollar strengthened. The recent attempts to stimulate growth by the ECB and the BoJ have incited concerns that central banks are running out of ways to stimulate markets and economies.

With the ECB and the BoJ both firmly committed to monetary easing at an unprecedented scale, investors over the next few months will focus on the ability of central banks to influence markets. Economic data as it relates to inflation, trade, and economic growth will in part show the extent to which central banks are reaching their projected goals. While the Fed in the US appears to be on track to restoring its dual mandate of optimal employment and 2% inflation, other central banks have had a lingering inability to do so. This highlights the ongoing concern that the authority of central banking authorities may be limited. While central bankers may purchase assets and cut borrowing costs, additional changes need to be made outside of the central bank’s power to restore growth and inflation. If the ECB and the BoJ prove unable to reach their goals with the extent of easing they are using, they may very well be out of ammunition. Most recently, central banks appear to have a limit on how far rates can go, which is bound by the negative pressure it puts on the banking sector. If rates get so low that the banking system starts to suffer, central banks will be faced with an entirely different set of issues.

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Friday March 11

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