We believe that the Joint ECB, FED action of last week was extremely significant. It amounted to stealth Quantitative Easing for Europe. This should continue to drive the market higher but expect volatility. The market result is the probability that the end of this year and the first quarter of 2012 will look similar to 2010.
In our note last week we indicated the high likelihood of some ECB action to lower the temperature of the crisis.
The significance of the joint action taken by the Fed and the ECB last week is easy to miss. The swop between the two central banks amounts to an expansion of the Central Banks balance sheets and is therefore Quantitative Easing.
The Euro crisis had two distinct elements to it.
The first was the much publicized sovereign debt squeeze, particularly on Spain and Italy.
The second dimension was the severe strain to the normal functioning of the European credit markets.
- Banks were not wanting to lend to each other or anyone else for that matter. European banks as of last week had parked $ 300 billion at the ECB.
- Banks were having trouble funding dollar assets. Investors particularly, US money market funds, preferred to park their funds in US Treasuries and had lost their appetite for European Banks.
- EU banks ability to issue uncovered bonds has all but dried up.
This second dimension was in our opinion far more serious in that it was starting to drive the real economy towards recession and could easily have evolved into a 2008 type of banking crisis.
The SWOP arranged last week is an elegant solution giving the ECB a tool to keep the pressure on the delinquent governments to act, but at the same time to take the pressure off the banks and thereby the real economy.
The ECB meets this Thursday and we expect further material action to reduce the pressure on the banking system and the real economy.
We expect this stealth Quantitative Easing to ensure a rally in risk assets through the year end and flowing into the first quarter of next year.