|What Happened [Yesterday]?|
Two days ago I asked if everyone was having fun. Today I can ask the same question. We know we are in a market dominated and controlled by news from Europe – whether you like it or not.
First, we got news China cut its reserve requirment. This motivates the banks to lend more aggressively. By itself this would give the market a little boost.
But the big news came later. Six central banks (the European Central Bank, U.S. Federal Reserve, Bank of England and the central banks of Canada, Japan and Switzerland) announced a coorindated effort to provide liquidity to the global financial system. The key is that it’s a coordinated effort, that a committmment has been made by numerous entities. Europe has help; they will not have to fend for themselves.
So what specifically does this mean?
Central banks loan money to each other. The US Fed effectively lowered its rate by 50 basis points. That means the ECB can borrow at a lower rate, then convert the dollars to euros, and then lend those euros to countries that are having a hard time raising money in the open market. It’s the equivalent to lowering the discount rate here in the US. It means when Italy is having hard time raising money in the private market (or when rates get too high), it can turn the ECB for a low-interest loan. There isn’t enough money in Europe to bailout all the troubled countries, so in steps the US Fed and other central banks with a promise to loan money to the ECB when the ECB needs it.
Italy will need to raise $400 billion euros in 2012. Currently the IMF has $100 billion euros that it can devote to Italy. Obviously this is a major issue. With the lowered rate, Italy indirectly has improved access to money. The US Fed has become the lender of last resort.
The market cheered this news. Instead of Italy and Spain missing a debt payment and setting off a negative chain reaction, they’ll have access capital when they need it. The market gapped up huge, held its gains all day and then rallied into the close. The Russell small caps rallied 6%; the Nas 100 lagged but still gained almost 4%. Every group I follow (there are over 100) moved up more than 1% and most gained 3 or 4% or more. Volume was huge. Wall Street breathed a huge sigh of relief – the world isn’t coming to an end…or so it seems.
But this doesn’t solve any problems. It doesn’t help Italy or Spain with their debt issues. It helps them make debt payments in the near term but doesn’t solve any other issues. It is a short term fix. All it does is buy a little time. Isn’t that the definition of kicking can down the road?
To me this news is nothing but a major warning, or admission on the part of the central banks that Europe is in trouble. Central banks are always calm and never show much emotion (think Alan Greenspan testifying). When things are good, they don’t get overly excited. When things are bad, they don’t want to cause a panic, so they don’t let on to how bad things are. But actions speak louder than words. It’s hard (or impossible) for the central bankers to justify this coordinated effort if things in Europe weren’t dire, if Europe weren’t about to unravel.
From a stock market standpoint, the effort is good news – the central banks are not going to let the system collapse. But what the move implies in not even slightly comforting.