Rumor has it that the European Central Bank (ECB) fears low inflation or even deflation so what should we do with our investments? Should we, as the old saying goes, “buy the rumor, sell the news?” In today’s article Chris Ciovacco, looks at what is expected from Thursday’s ECB statement and what to do about it.
QE Hints Or Lack Thereof Key To Thursday’s ECB Statement
- The European Central Bank has telegraphed most of what will be contained in Thursday’s statement.
- The wild card, in terms of market reaction, most likely lies in if/how the ECB addresses the subject of quantitative easing.
- From an investment perspective, the markets have most likely priced in the core portions of the Thursday’s ECB statement; QE is the exception.
- Since QE can impact stocks, bonds, commodities, and currencies, the market may be disappointed if the ECB fails to hint at the possibility of implementing a QE program.
What’s The Problem In Europe?
There are numerous problems, including persistent low inflation and a wide spread between lending rates for borrowers in different countries. Borrowers are paying higher interest rates on loans in Italy and Spain relative to Germany and France. The economies in Spain and Italy are much more in need of the economic benefits of low borrowing rates, which can spur building, investment, and hiring. We have touched on the problems associated with low inflation in the past; an issue on the ECB’s short-term radar.
“We’re very aware of the fact that an extensive period of low inflation carries risks.” ECB president Mario Draghi
The Telegraphed Expectation
The head of economic research at Open Europe, Raoul Raparel, handicapped the widely expected key moves to be announced by the ECB. From Forbes:
- Cut the main interest rate to 0.15% (from 0.25% now).
- Cut the deposit rate to -0.1% (from 0% now). This will be an unprecedented move.
- Announce a new Long Term Repurchase Operation (LTRO) focused on boosting lending to small and medium sized businesses. The term will be between 3 and 5 years, rates will be reduced if banks provide evidence of a pick-up in lending (see below for a useful Nomura graphic on this, the 1st and 2nd options are most likely).
Buy The Rumor, Sell The News
If there is little-to-no mention or hinting of the possibility of future QE in the ECB’s statement, the odds of a negative “sell the news” reaction increase. From Bloomberg:
Yields on bonds from Belgium, France, Italy and Spain have fallen to records in the past month amid speculation policy makers meeting tomorrow may add unconventional measures, such as quantitative easing, in addition to lowering interest rates… “We see a high risk there will be disappointment,” Cosimo Marasciulo, Dublin-based head of government bonds and currencies at Pioneer Investment Management Ltd., which oversees about $244 billion, said yesterday. “The market is looking for some form of QE, or at least an opening of the door to QE, and we think the ECB will be reluctant to do this. Those who bought bunds and Italian bonds on expectations that QE in the euro zone was very close may be disappointed.”
Investment Implications – Don’t Expect A QE Announcement
The odds of the ECB announcing plans to begin a QE campaign are not zero, but they are very low. We are looking for hints or “we are open to” language in the statement. Experienced traders and money managers will tell you that it is not the news that matters, but the market’s reaction to the news. They will also tell you predicting how the market will react to any given news event is difficult at best. Therefore, our strategy will be the same as it always is…we will make decisions based on observable evidence in the stock, bond, commodity, and currency markets, which means we will wait for the market’s reaction, rather than trying to anticipate it.
Until Something Changes…
The observable evidence has called for a mixed allocation of stocks (SPY) and bonds (TLT), with stocks getting the bulk of the exposure. What do we mean by “observable evidence”? Our market model uses numerous inputs, such as the moving averages shown below.
The current profile is not a high-risk of an prolonged equity plunge profile, which means something has to change for the stock market bears to take control. News events are often catalysts for change. We have two big events left on this week’s calendar; the ECB announcement and Friday’s labor report in the United States. If we monitor the markets and incoming data with an open mind, we can maintain the required flexibility to stay within the confines of a prudent investment allocation.
This article originally appeared on ciovaccocapital.com and is reprinted by permission.
About Chris Ciovacco