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European Central Bank & the Federal Reserve

Nearly two years ago, European Central Bank (ECB) President Mario Draghi, who is the euro-zone’s counterpart to Fed Chief Janet Yellen, said the central bank would do whatever it takes to preserve the euro. He added for emphasis, “Believe me, it will be enough (Bloomberg).”

 

His bold statement was enough to attract investors back into Spanish bonds, which at the time were on the brink of default. Today, yields on longer-term Spanish bonds are at a record low (Bloomberg).

 

A default by Spain would likely have been followed by serious tremors in the troubled nation of Italy, which sports the world’s third largest bond market (Financial Times). It’s a too big to fail, too big to bail out scenario that would have threatened much or all of Europe.

 

But what troubles Europe today is not the immediate threat of a debt crisis. Instead, it’s a rate of inflation that has fallen to a dangerously low level; just 0.5% versus one year ago (Eurostat). For comparison purposes, the U.S. Consumer Price Index increased at a year-over-year rate of 2.0% in April, per the latest BLS data.

 

Falling prices may sound appealing at first glance, but it’s a dangerous downward spiral that’s best avoided. Once a deflationary psychology takes hold, some might decide to delay purchases amid expectations of even lower prices.

 

That in turn could quickly throw an economy into a recession, further depressing the price level. It’s akin to an economic black hole. A look at Japan’s experience over the last two decades is a sobering example.

 

ECB action

The ECB cut its key lending rate from 0.25% to a record low of 0.15%. More importantly, it cut its deposit rate, or the rate banks earn on their reserves, from 0% to -0.10%. It’s the first time a major global central bank has implemented a negative rate. In addition, the ECB announced targeted measures that are also designed to encourage lending and modestly boost cash in the financial system.

 

What it did not do is launch a controversial Federal Reserve style bond-buying program, though Draghi did hint that more measures may be in the offing. "Are we finished? The answer is no. If need be, within our mandate, we aren't finished here (ECB transcript of the press conference),” Draghi said.

 

Draghi is the master of rhetoric, able to craft just the right statement at just the right time. On the flip side, I might add that the German press was dismayed by the new measures, lamenting that already low interest rates on savings could go even lower (Wall Street Journal).

 Blog June 9  2014

Note: the fed funds rate is targeted by the U.S. Federal Reserve. It is included for comparison purposes.

 

Goals

The ECB has several objectives in mind. Encourage lending by placing a small penalty on excess reserves. It would also like to weaken the euro by making the currency a less attractive place for investors to park funds because a weaker euro should raise the price of imports and support inflation. It also makes exports more competitive, aiding a weak and fragile economic recovery.

 

Will it work is another matter. A reduction in its key rates by just 0.10 percentage points is not enough to fix what ails its economy, as the opportunity cost not to lend went by just a fraction of one percent. But the psychological impact may be more important, and Draghi’s insistence that we may see even more aggressive measures got the attention of Wall Street.

 

Importance to U.S. investors

As the Federal Reserve is gradually reducing its rate of bond purchases, which has slowed the U.S. rally this year, Europe may be set to launch its own version. The possibility new cash may pour into the global financial system encouraged bullish sentiment.

 

The result: both the Dow Jones Industrial Average and the broader based S&P 500 Index claimed another record high (Wall Street Journal). It also lent support to the recent rally among the riskier smaller-company stocks, which have taken a modest beating in recent weeks.

Market Update - June 2, 2014

“It’s impossible,” said pride.

“It’s risky,” said experience.

“It’s pointless,” said reason.

“Give it a try,” whispered the heart.

-Unknown

 

The markets started off the week posting some slight losses, but seem to have now slipped to the upside.

 

In an unusual move, the ISM (Institute of Supply Management) changed its May manufacturing report to 56.0 from the initial report of 53.2, due to a software error that applied last month's seasonal adjustment factor to this month's data. The revised reading is slightly above forecast for 55.5, according to Reuters.

 

Later this week, we will be looking at other economic data including reports on factory orders and car sales. This Friday, the latest Labor Department jobs report figures will also be released.

 

Index

Weekly   Return %

thru   May 30, 2014

YTD   Return %

Dec 31, 2013 – May 30, 2014

DJIA1

+0.7

+0.9

NASDAQ Composite2

+1.4

+1.6

S&P 500 Index3

+1.2

+4.1

Bond Yields

May 30 Yield & Weekly Change

Yield -   % a/o Dec 31, 2013

3-month T-bill

0.04           Unch

0.07

2-year Treasury

0.37           Unch

0.38

10-year Treasury

2.48           -0.06

3.04

30-year Treasury

3.33           -0.07

3.96

Commodities

May 30 Price & Weekly   Change

Year end 2013

Oil per barrel4

       $102.93             -1.46

   $98.42

Gold per ounce5

$1,250.50           -41.00

$1,201.50

Market Update - May 29, 2014

Stocks are showing modest gains thus far today, as the S&P 500 pushes further into record territory.

Investors were digesting the latest economic data that included a drop in jobless claims to near 2007 lows. This seems to suggest continued improvement in the labor market.   We also saw a downward revision in gross domestic product that showed the economy contracted 1% in the first quarter.

The yield on the 10-year Treasury note continued to fall, dropping to 2.41% from 2.44% late Wednesday. Long-term interest rates are at their lowest for the year.

Market Update - May 22, 2014

This morning we are seeing a slight uptick in the markets primarily due to hopeful signs for the housing market. Existing homes sales jumped 1.3% in April, the National Association of Realtors said. It was the first monthly gain of the year. We also got some positive earnings news from some retailers, contrary to those reported earlier this week.

Ahead of the open, the Labor Department reported initial claims for jobless benefits rose by 28,000 to 326,000 last week; with the four-week average down 1,000 to 322,500.

The Conference Board announced its index of leading indicators, a measure designed to gauge the economy's future health, rose 0.4% in April.

The Memorial Day weekend is upon us. The bond market will close early at 2 p.m. ET this Friday, and the stock and bond markets will be closed on Monday May 26th. Loveless Wealth Management will be closed on Monday May 26th in honor of the holiday. We will resume normal business hours on Tuesday May 27th.  Have a great weekend!

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