Picking up on our comment yesterday following the ECB’s press conference, the market reaction has been more than gleeful. On Wall Street, the major indices hit new post-financial crisis highs and the FTSE Eurofirst 300 Eurozone Index has now convincingly broken through the resistance shown in the chart on the next page. Both the Spanish and Italian bond markets performed well and importantly, so did eurozone banks – and not just Spanish and Italian banks, but French banks too. You judge a financial crisis by the banks and the reaction in the board rooms, which must now be applauding Mr. Draghi. First came LTROs (Long-Term Refinancing Operations) and now come OMTs (Official Monetary Transactions).
Our line used repeatedly in notes along the way has been that the eurozone sovereign debt crisis put at risk the stability of the financial system and with this the stability of the global economy. Our line on the last EU summit meeting in June was that it provided something of a watershed for the leaders of the eurozone in agreeing to what was the ‘vision’ for full integration, starting with the banks.
That meeting likely laid the ground for Mr Draghi’s re-think, not just on the need to ‘repair’ the transmission mechanism for monetary policy, but for a more progressive and cooperative approach to ECB policy in helping, rather than obstructing, the long term ambition of full integration and debt sustainability for the eurozone. And while the Bundesbank may think otherwise, the ECB is now ready to help in a manner that falls within its remit for monetary policy,
Mr Draghi’s hope is that the new ECB initiative does the ‘trick’ in removing tail risk from the euro area. If perceived as such, the global outlook should improve. The OMTs programme should go some way to mitigating the prevailing uncertainties that central bankers have been pointing to as inhibiting growth throughout the global economy. In the context of our own line, the risk to the stability of the financial system should diminish and with this the risk to the stability of the global economy. Indeed, it is very likely that expectations for global economic growth and corporate earnings, both of which have been losing momentum, will be revised up before long, that is, leaving aside the matter of the US ‘fiscal cliff’ for now.
On this view the response by equity markets to what was a well leaked press conference, should prove not to be a one or two day wonder but something that sets the tone for them over the coming months. All other things equal, a re-rating is justified. Also, if the risk to financial instability is diminished and the uncertainties affecting the outlook for the global economy mitigated, a reappraisal of the flight to quality in the major government bond markets should get underway. Indeed, might Draghi’s trick be the basis for the turn?
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