Equity markets started the day well as Asia recovered overnight after China announced better than expected trade data. Equity markets once again flirt with the top end of their trading ranges, teasing investors with the prospect of breaking new ground.
Investor sentiment remains cautious boding well for equity markets, day traders steadfastly back an equity correction, this also bodes well. The Dow Transport index that some look for as a lead indicator for equities also remains supportive, trading close to its highs. On the contra, the Nasdaq continues to show no signs of recovery, trading back close to its lows earlier this year. US equities, which reacted negatively to a strengthening bond market over the past year, have so far ignored the recent strength (see chart below). The US dollar basket (DXY) has weakened recently, this is despite the rally in the bond market, that move is counter intuitive to what one would expect. If investors are buying US treasuries they are investing in the currency to do it, one would have therefore expected the US dollar to be rallying. Fear remains on the back burner as the Vix remains close to the bottom end of its trading range.
Janet Yellen repeated in a speech this week that she will continue to support the US economy. The ECB and the BofE left interest rates unchanged on Thursday, both largely expected. Frank Investments did expect the ECB to move, if the ECB are planning to stimulate the economy, what is to be gained by waiting? To us it has to throw into doubt the ECB will move at all.
Thursday's decision will refocus the deflation debate within the eurozone. Thursday's Telegraph ran a piece discussing whether Europe's elite remain nonchalant about the deflation threat staring them in the face, perhaps they don't share the conventional view that letting it happen is a policy failure. Traditionally, deflation is viewed as being the result of a weak economy, debt becomes more valuable and harder to pay off, not helpful in a highly indebted economy. The article suggests that some members of the ECB would welcome deflation in the eurozone, basing their view on Jaime Caruana's (head of Bank for International Settlements) recent speech that historical evidence shows deflation has been associated with growth output, while the great depression was the exception to prove the rule. He points to times in history when economic growth was strong during periods of protracted deflation (England mid-19th century, Germany 1880- 1913). Mr Caruana does not like quantitative easing as central banks run out of ammunition and create instability. The eurozone is the weakest region of the OECD, and yet the euro is the hardest currency, pushing the region closer to deflation. The last paragraph makes the most interesting point “why do the voting publics of the debtor states (read Spain and Italy) continue to put up with an arrangement that dooms their nations to bankruptcy when the global cycle turns”. The answer may lie in ignorance, blind faith or perhaps the possibility that ultimately they won't.