Draghi makes the right noises to calm markets ...... We've been here before, haven't we ?

Friday 22nd January 2016

Draghi makes the right noises to calm markets ...... We've been here before, haven't we ?

ref :- "Draghi faces test to deliver after dashing hopes" , the Financial Times , p.6 and online

After all the blood-letting of the first three weeks of 2016 that has beset equity markets in particular, the relative calm that set in on Wednesday has been followed by what investors will be hoping is the start of a recovery with a number of stock indices being able to climb back above the "20% decline from recent highs" level that constitutes a bear market. How much significance should we attach to that ? Frankly, none. The upward moves are welcome and not before time but don't disguise the fact that these markets are still vulnerable, to say the least.

Part of the rally can be put down to a jump in oil prices (yes, really). If you'd been on another planet for a year or so, a rise of $3.60 per barrel in the price of crude oil would barely register. But from a low of say $27.40, trading at $31 represents a rise of more than 17% in just two days  --  now that  must mean something. Actually no ..... the fundamental picture for crude has changed not one jot. We've warned before about how markets in which the speculative positions are largely pointed one way are susceptible to sharp, even violent moves in the other direction when the players rush to cover their positions. In the crude market, for obvious reasons the speculators have been overwhelmingly short, to record levels in fact. Technically, only a break through resistance at $34 would start ringing bells, though many would just see it as a selling opportunity. At this stage, and to use a trading catchphrase, it looks like a "dead-cat bounce". You can expect more of them from time to time.

Anyway, the main impetus behind the relief rally was European Central Bank President Mario Draghi, and what he had to say about what the ECB might do by way of stimulus in March should growth and inflation fail to pick up. Since there is little or no indication that either is likely, the market took this to mean that the ECB almost certainly WILL act to counter the threat to both those goals posed by a China-led slowdown in emerging markets and plunging oil prices. Quite what combination of rate cuts and expansion of the QE programme might be adopted will of course be the subject of much speculation.

Mr Draghi has taken a lot of stick since the stimulus measures the ECB introduced in December underwhelmed many market players who felt that the rhetoric in the run-up to that decision had (mis)led them to expect stronger action. Those critics will no doubt now be saying that the fact that the ECB is very likely to have to take further action in March proves their point, and certainly you could make a valid argument that the ECB is being reactive rather than proactive. But we'll go slightly contra-trend in having a little sympathy for Mr Draghi. People forget or chose to ignore the fact that there was a significant minority within the ECB arguing for no further stimulus whatsoever, including the powerful German lobby. Others were happy with a cut in the discount rate but were soundly against any extension or expansion in Quantitative Easing. The kind of measures that the critics were expecting were never a foregone conclusion, not by a long chalk. And anyway, who was to know that oil would tumble another 30% ? OK, don't answer that one .....

It would be fair to say that communication has not been a strong area for Mr Draghi of late, but in part at least that's the result of how elements within the market now expect and even demand from central banks the kind of "forward guidance" that will definitively map out the course of future policy decisions as if written in stone. We could also add that many of the same people seem to think that it's a central bank's role to support asset prices  --  but we're always banging on about that one so we leave it for now. The trouble with this kind of forward guidance is that circumstances change and consequently policy, or at least strategy, will too. It's not ideal, but then markets aren't.  Traders must be responsible for making decisions of their own that consider all possible outcomes, and not expect central banks to hold their hands every step of the way  --  which is what they've become used to, it seems. Of course it's usually the ones who have lost the most money who complain the loudest, which probably sums it up better than anything.

And whilst we're on central bank stimulus ......

ref :- "Bank of Japan faces pressure for further  monetary policy easing" , the Financial Times p.6 and online

Just a quick one ..... the BoJ meeting next week will consider whether yet more monetary stimulus is appropriate in the face of the global slowdown, tepid domestic performance and an almost complete absence of inflationary forces. Beyond those minor issues, they will also debate whether further easing should be applied to counteract the strength of the Yen, which has benefitted from safe-haven buying and only increases deflationary concerns.

It had been hoped that wage rises would fuel upward moves in consumption and therefore in inflation, so in a strangely "world-turned-on-its-head" moment, the BoJ will be disappointed by the latest wage demands from the powerful car workers unions. They are asking for a monthly rise of Y3,000, half of last year's demand of Y6,000 though they settled for much lower. To put it in perspective, Y3,000 equates to about $25. The unions take the view that their demand accurately reflects a year-on-year rise in prices to November of 0.3%.

We can't speak for everyone of course, but for those who remember the UK of the 1970s and early 1980s, that seems a remarkably responsible negotiating position.

Oh ..... and the chances of a January move by the BoJ ? According to JP Morgan, a little less than 50% but rising ......