Europe Goes Crazy But Effects On U.S. Should Be Short Lived

All hell broke loose as the European Central Bank lowered interest rates but not as much as anticipated. Additionally, head of the ECB Mario Draghi essentially said he would pull out all the stops in order to stimulate the continent’s lackluster economic performance.

The quantitative easing the ECB has been engaged in was extended into the first quarter of 2017, an expansion beyond the prior ending target date of September 2016.

The first effect the announcements by the European Central Bank was to light a stick of dynamite under the euro, which started the day at less than 1.05 to the U.S. dollar and may now be heading toward 1.10 on the day, a rise of well more than 3.00% at 4 PM in New York.

Draghi said the central bank could make more strategic moves later if called for and described the decision to reinvest principal repayments on bonds it has already bought to maintain liquidity as "very significant." This reinvestment is key.

Couple the euro QE with the distinct possibility that the U.S. Federal Reserve will raise rates and we are looking at a significant spread opening between the dollar and euro. Although it doesn’t seem obvious today because of the screamingly higher euro, the U.S. dollar will emerge from this rate-setting fracas much stronger for a much longer time.

Today, the strengthening euro dragged gold up with it (because the dollar was down). Without dollar weakness, gold would have been down $14.40. However, the dollar brought up the price $23.50, so gold is trading at a net gain of roughly $9.00.

All the precious metals were up, even punch-drunk palladium. It rose 1.70% while platinum was up 1.80%. Silver did well, too, rising around 0.80%.

Crude oil prices in both the U.S. and international markets were helped by the dollar’s faltering value. West Texas Intermediate jumped almost 3.00% and Brent North Sea oil was up over 3.00%.

We do not look for this to be a long-lived phenomenon. There was lots of tea and sympathy at the OPEC meeting in Vienna, but little resolve either in or out of the cartel to push prices higher.

Key players like Saudi Arabia, Venezuela and Russia (outside the cartel) need all the cash they can lay their hands on and cannot gamble on pushing production lower and allowing the heavy North American hitters to reenter the game too quickly.

These various factors combined to hit U.S. equities fairly hard, although again we caution that fundamentally speaking this trough won’t last long. We think after a brief period of adjustment, which will end when investors jettison their fears over the rate brouhaha, pricing in U.S. equities will head up again.

It is noteworthy that U.S. yields for the 10-year T-bond breeched the 2.3% level. This is a level that is confirming the opinion that when Janet Yellen and the rest of the Federal Open Market Committee meet in less than two weeks they will raise rates.

There are two possible bones in the throat. The first we discussed above briefly, which is the European Central Bank’s stimulus measures. The second is tomorrow’s U.S. Department of Labor’s employment report for November.

Unless it is close to disaster territory, the jobs data won’t stop the Fed. Chances of it being disastrous? Well, the private employment report issued yesterday by ADP showed the creation of 217,000 new jobs, an annual rate of more than 2.6 million per year. 

Wishing you as always, good trading,