The global rally in equities as a result of central bank fueled liquidity injections has taken a breather to begin the new trading week, with the effects of the European Central Bank jawboning and an interest rate cut from the People’s Bank of China starting to fade on Monday morning. The Shanghai Composite was dangerously close to finishing its session in the red, when a late-day rally allowed the index to close higher by 0.5%. The Japanese yen is eliciting capital flows as sentiment in financial markets turns bearish, with participants keenly aware recent comments from two of the main advisers to Prime Minister Abe have suggested the chance of further stimulus measures from the Bank of Japan this week is fading. The Bank of Japan meets Thursdaynight/Friday morning, with nearly 50% of the economists surveyed expecting additional easing measures from the BoJ. The situation for the BoJ is markedly different from Europe, with policymakers remaining vehemently optimistic the economy is on the right track, while the incoming data points have signalled a deterioration in activity along with headline consumer prices. Consumer spending has yet to gain a strong footing in the post-tax hike era, however the labour market remains tight and core inflation readings that exclude food and energy remain around 1%, keeping policymakers sanguine despite the potential of third quarter GDP signalling the economy contracted. Policymakers have suggested the potential growth rate in Japan is close to 0.5%, and with normal gyrations around that annualized path, quarters of contraction will become more frequent going forward, and is likely the main reason policymakers don’t seem bothered enough by the incoming data points to hint additional balance sheet expansion is on the horizon. That being said, the surprise increase in the monetary base was announced at last year’s October meeting, with policymakers having no problem stating that surprise announcements have a much better market reaction as opposed to market participants anticipating the news.
European equities are mixed midway through their session, reflecting the cautious price action permeating around the globe as traders make it back to their desks after the weekend. The euro has managed to stem its bleeding against the big dollar, with two days of fervent selling pressure seemingly abating for the time being. The strong hints that further balance sheet expansion from the ECB may be necessary as early as December hit the common-currency hard at the end of last week, with participants finding a renewed passion to utilize the euro as a funding currency as the re-emergence of the carry-trade appears. The divergence in monetary policy has not transpired as originally anticipated in an environment where liquidity recycling is struggling, though even with Fed policy on hold, the ECB has taken the reins for further monetary policy accommodation and seem content to open the liquidity spigot wider. The need for international investors to hedge their euro-denominated assets, along with the ability of the euro to act as a funding currency for carry-trades, will likely keep the common-currency under pressure into 2016, though like we have witnessed recently, the speed of monetary policy divergence between the Fed and ECB is progressing in a slower fashion than originally anticipated, and the big dollar will be susceptible to air pockets as expectations evolve.
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