Equity
and Currency Pricing are Looking More Normal, but Currencies also Show Caution
Currency/equity prices showed a noted divergence
late last week. S&P went up where euro went down and U.S. dollar went up. Going
into this week, risk appetite seems more in play with currencies. But
interesting to note is 1.3000 appears to be key resistance for euro and 80 key
support for U.S. dollar. Today, Equities are showing strength, but currencies
seem less convicted.
Euro’s daily chart shows moderate price increases
for Monday and Tuesday. However, MACD histogram continues to weaken with the
indicator threatening to turn down. For U.S. dollar, it’s in decline, but its
MACD histogram also seems week. Equities, in contrast, simply look strong.
Looking at these asset correlations, one can see
decided influences that drove pricing among the three assets. Any divergence in
past correlations raises a warning and indicates potential of a change in
dynamics, or one asset class front running the others.
Below is a continuation of last article “Currency/Equity
Asset Pricing Correlations Part I: July to August.”
Last article looked at July through August market
activity among U.S. dollar, euro and equities. Notable were ECB negotiations
with Germany. While negotiations initially were framed by public comments and
affirmed by markets, an agreed policy was announced in September.
Looking at September, August’s developments came to
fruition.
ECB
and Fed Comments Brought Cautious Optimism to Markets, But German Comments
Confused Markets
After Mario Draghi’s remarks of doing what it takes on
July 26, markets found optimism in August due to expressed ECB commitments. Markets
held an optimistic caution with release of Fed minutes on August 22.
Until August 22, equity markets moved up on an
escalator, with slow steps made every day. On August 2, S&P closed at
1,365, and on August 20, S&P closed up 1,418. Same time period, euro and
U.S. dollar proved unconvinced and moved sideways.
Day before release of
Fed minutes, August 21 saw S&P drop from a four year high closing at 1,413
and Chicago Board of Exchange equity volatility index (VIX) gained 7% ending at
15.02. Where equities fell and VIX indicated larger declines ahead, U.S. dollar
looked decidedly risk on opening at 82.46 to close down bullishly at 81.91.
Euro demonstrated a rise breaking its drift.
Early on August 21,
equities started a rally on reports that ECB would start buying Spanish and
Italian debt. Also encouraging was German Chancellor Angela Merkel remarked
that Germany would do whatever it could to support the euro, mirroring ECB’
Mario Draghi’s statement of July 26.
Dashing rallying
equities was a Deutsche Bundesbank statement critical of both Draghi’s and Merkel’s
remarks. German Central Bank said it was hesitant to engage in euro system sovereign
bond purchases with such purchasing posing a risk to stability.
Apparent
Consequences of Confused German, European Direction
Close of trade on
August 21 saw market participants walk off the field confused over conflicting
remarks. Equities took the conflict to hart and went risk off. Currencies saw a
brighter side and went risk on with dollar declines and euro advances.
August 22 didn’t revive
equities, as otherwise expected. But currencies continued in bullish fashion.
Federal Reserve minutes of their July meeting were released. Minutes revealed a
consensus to engage in a new QE program soon should no economic improvement
develop. This comment made QE almost assured, save a miracle in economic
indicators. Given trends in economic indicators, no miracle could reasonably be
foreseen.
Despite Fed assurances,
equities declined on August 22 and VIX increased. From there, equities went
into a mild downward slump until September 6. U.S. dollar on August 22 fell .42
points and euro took off upward.
Euro closed on August
20 at 1.2347 and opened August 21 gapping up to 1.2436, up some .89 pips. By
August 22, euro closed at 1.2529.
U.S. dollar then began
a slight rise reflecting a mild decline in equities. Euro however engaged in a
sideways bullish push up. Overall indications suggest market confusion due to
conflicting remarks, but confusion was optimistically skewed given currency
movement.
Euro
Strength Foretold Market Response to ECB and Fed Easing Announcements
September’s policy
statements from central banks kicked off a rally that would gird markets until
Q3’s earnings season.
Simply stated, ECB and
other European stakeholders worked out an approach despite previously confusing
statements. On September 6, ECB announced their Outright Monetary Transactions (OMT).
In order to activate such bond purchasing, ECB explained that a country must
first request assistance. Thereby the country would subject itself to fiscal
review and necessary austerity. Still S&P leaped up opening at 1,403 and
closing at 1,432, up 29 points.
Euro experienced a
major gap up in overnight trade and opened September 7 in U.S at 1.2704 to close
up some 111 pips at 1.2815. U.S. Dollar relaxed finding itself down at 80.25
from an opening of 81.04.
Further juicing a
bullish market was a September 13 Fed announcement revealing its $40B/month in
mortgage backed securities (MBS), without a time frame. All markets, currency
and equity alike, responded in bullish fashion.
Market
Euphoria Turned into Sobriety Due to Limitations of Easing Prospects
September 17 marked an
S&P multiyear high, a euro high and a U.S. dollar low. Leading to September
17 was a four day bull party for markets resulting from a September 12 German
high court decision approving Germany’s participation in Europe’s European Stabilization
Mechanism.
September 17 witnessed
an end to a party fueled by central bank announcements and a critical German
high court decision. On September 17, Dow fell .3% down to 13,553, S&P fell
.3% to 1,461 and VIX increased .6% closing at 14.59.
Breaking up a bull
party appears to be reality setting in on ECB OMT transactions. Markets
realized no major bond buying would occur in Europe. In fact, for bond buying
to trigger, it became evident European countries would have to sacrifice sovereignty
in exchange for assistance. Also, for Fed announcement, MBS purchases implied
bank responsibility to create mortgages in order to create MBS’s, thereby
feeding Fed purchases.
Come October, central
bank propositions were known and expectations started to price in. From
September 17 to October 18, U.S. dollar trended up, euro formed a cup and
S&P failed at a triple top.
Q3
Earnings Season Turned Sobriety into Depression and Banks Disappointed with
Good Earnings But Bad Interest Margins
Essential reality set
in prior to an expected disappointing Q3 earnings season. Reality revealed that
ECB efforts would only be triggered upon country request. Meaning markets would
not see any immediate bond buying by ECB. Greek experience juxtaposed against
Spain to tell hesitation of countries requesting ECB assistance. Still Spanish
and Italian bonds cooled.
For U.S., Fed’s QE3
wasn’t an open purchase of assets as in last two QE experiences. Rather, with
QE 3 being restricted to MBS, banks realized that they needed to create
mortgages to feed the MBS purchasing machine over time. Troubling for this
proposition was realized as banks released earnings in Q3. One phrase cooled
U.S. equities against QE3: Net Interest Margin.
With Net interest
margin having been in decline, and higher earning securities obviously coming
to maturity, issuing new mortgages at very cheap interest looked challenging
for bank income. Suggested was/is banks must make up difference in margin with
fees, service charges or trading. But Dodd-Frank legislation restricts other revenue
stream capacity.
Apparent to markets was
a Fed effort to grow U.S. economic propositions by growing real-estate. But to
do so, banks remain a cautious partner due to interest margins. ECB’s OMT exist
only once called upon by a particular country.
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