Now here is an impressive chart. Despite all the bother for markets – to put it lightly – including a quite unremarkable earnings season on both sides of the pond, expectant markets continue to climb the wall of worry noted in a recent market comment, but more on this later.
June’s EU summit marked something of a turning of the tide on eurozone integration. That was, and still is, our view. It has also helped open up what is now a challenge underway to the Bundesbank dominated mind-set of the European Central Bank (ECB). What will come of this remains to be seen but Mr. Draghi pulled no punches with his comments last week; ‘the ECB is ready to do whatever it takes to preserve the euro’ … ‘to the extent the size of the sovereign premia hamper the functioning of the monetary policy transmission channels, they come within our mandate … and believe me, it will be enough’. But there was much else said last week by others.
Spain, Italy and France called for a swift implementation of the decision taken at June’s EU summit and specifically for the use of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) to be used in a ‘flexible and efficient manner’ as agreed to ensure financial stability for the eurozone. Over the past weekend, Mrs. Merkel, in a conversation with Mr. Monti, endorsed the view that the EU summit conclusions must be implemented ‘as quickly as possible’.
At the end of last week came the story released by Le Monde on how the EFSF (and ESM) might work in cooperation with the ECB to support bond markets. Draghi inspired or not, the plan, as reported, involves the participation of the EFSF in the primary market for Spanish and Italian debt with the ECB participation in the secondary market. How much of this comes as news for the Bundesbank is uncertain, but Mr Draghi is in talks this week with its President, Jens Weidmann, ahead of Thursday’s ECB meeting.
Also, last week, Belgium’s former Finance Minister and now Foreign Minister, Didier Reynders, questioned the narrowly defined brief of the ECB and made the point that its role could include helping governments struggling in debt markets. The President of Austria’s central bank and Governing Council member Ewald Nowotny, bucked the Bundesbank line in commenting on the merits of a banking licence for the European Stability Mechanism (ESM).
It is hard to imagine that a review of the ECB’s mandate might end up on a future EU summit agenda. However, it is not inconceivable that discussion on this, in conjunction with banking integration and the role of the ESM when it comes into being, extends beyond the ECB’s Governing Council. The fact is the pressure is building on the ECB for a mandate consistent with a broader set of interests in the march to full integration for the eurozone.
Mr. Draghi did encourage markets by pointing to the rationale for the ECB’s Securities Market Programme (SMP) – malfunctioning or stressed-out bond markets interfering with the transmission mechanisms for monetary policy. Whether that characterises the Spanish and Italian bond markets is an open issue but his comments suggest that the ECB is ready to provide some kind of support operation, be it via the reintroduction of the SMP and/or by some other means. Hopefully, we shall find out on Thursday. Either that or we are in for one big disappointment.

As for the Fed, which meets this week too, the FOMC will likely wait for September’s meeting before moving ahead with more stimulus. This is when the Fed’s economic projections will be updated and revised to reflect the economy’s loss of momentum. It is hard to tell just where the conviction lies within the FOMC for more stimulus but the last set of minutes spelled out the conditions under which it could be warranted and if the economy loses more momentum, the FOMC will go for it, as we expect. Aside from this week’s ISM surveys, Friday’s non-farm payrolls are the first big number for the third quarter. The tone underlying the hawkish sentiment within the FOMC has modified somewhat already. A poor number will raise that conviction level for Fed action.
Given that the Bank of England has just extended its QE programme, no change is expected when it announces its decision on Thursday ahead of the ECB’s. The BoJ does not meet this week but its own thinking is also swinging round to the need for more stimulus.
Finally on earnings, the US results have been unremarkable overall but far from disastrous. The estimate for quarterly earnings in aggregate for the S&P 500 is now up a little from where it stood at the start of July, but expectations were low going into the reporting season. By the end of this week, about 80 percent of the S&P 500 will have reported. For Europe, earnings are down year-on-year for the Bloomberg European 500, but less so than during the earlier stage of the results season.
With the loss of global economic momentum coming through to the top and bottom lines, the extent to which equity markets can be expected to move ahead must be limited. However, in spite of this and other worries including the ‘fiscal cliff’, the S&P 500 is less than 2.5 percent off its post-financial crisis high Wall Street has managed to do surprisingly well, in large measure due to the Fed’s supportive role.
Action speaks louder than words and Mr Draghi’s words rang loud and clear being delivered, as not before, to a pre-Olympic London Conference attended by other central bankers and dignitaries from around the world. This was not just another press briefing following an ECB Governing Council meeting and, certainly, the ECB President would not have wished to put his credibility at risk by overdoing it. So perhaps he did let something out of the bag. Certainly, it has helped Italy gets its auctions away.
Imagine how market sentiment might change for the better if the ECB was to provide support for the bond markets, even if the intervention is sterilised. Besides the Fed, China is now doing its utmost to arrest the economy’s loss of economic momentum. It is cutting interest rates in addition to lowering reserve requirement ratios and also adopting a more active fiscal policy to complement the monetary stimulus. With the BoE also extending its QE programme and the BoJ thinking of doing much the same, all the major central banks would be seen as pulling together to help underpin and reflate global economic activity. This could easily renew the risk-on trade and this might be happening already. Indeed, that channel of rising highs and lows for the one equity market that still provides financial leadership may be reflecting just this.

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