Stabilization Taking Hold

Intra-day activity may still be a bit unsettled, but some semblance of stabilization is emerging.   Global equity markets are advancing in the wake of yesterday's neck-breaking moves in the US that left the S&P 500 4.75% higher net-net on the day.  Other bourses haven't matched that, but the direction is generally the same.   The dollar itself is mixed; flattish against the euro and dollar-bloc, stronger against sterling and the Swiss franc and weaker against the yen.    With yesterday's FOMC commitment to keep rates low until mid-2013 at least and the rally in the US 2-year note that pushed yields to within the Fed funds target range, has pushed the US premium to lows not seen since the early 1990s.  While the dollar is below levels seen before the recent round of BOJ intervention, the loss of the Japanese discount suggests a fundamental force behind the yen's strength. 

Despite the signs of stabilization, something remains amiss.   The euro is encountering resistance near $1.44 and the ECB bond buying seems to have reached a point of diminishing returns as Italian and Spanish bonds yields gravitate around 5%, from above 6% last week.  Even though equities are hgigher and peripehral bonds are higher, Germany bunds have also rallied and spreads have widened at lower yield levels today. 

This could be partly a function of what the Federal Reserve did yesterday.   The fact that rates will remain low until the mid-2013 seems to ratify what the market had already largely concluded, moving the first hike into early 2013.  Giving a more precise time frame has been tried by other central banks--like the Bank of Canada.  Other central banks, like Norway and Sweden, have been even more transparent by suggesting the path of policy as well.  The three dissents over the specific time frame underscore the importance of the Fed's signal--taking some modest measures is more important than achieving a consensus.  Clearly, the Fed is keeping the door open to new asset purchases and/or other action, if needed.  The issue is where is the bar now in the sense does the economy have to deteriorate further or if it simply does not improve will that bring more action ?

The BOE's inflation was largely in line with expectations.  Growth forecasts are cut and inflation is expected to peak toward the end of the year.  A new round of asset purchases is not imminent, but it may new economic weakness and the fall in oil prices and the passing of one-off factors could bring it on. 

If the stabilization sticks, some of the beaten up emerging market currencies, like Mexico and South Africa will likely do better.  The Swiss franc, which has advanced 40% against the dollar in the past year, can begin consolidating.  The yen may hold up better on economic recovery and narow interest rate differentials.