Eoin Treacy's view There
has been a great deal of speculation on whether the Fed is thinking of removing
its stimulus and if so by how much. Investors have come to rely on virtually
free access to credit in order to fund speculative participation in stock markets
and other assets so a change to this source of funding would be cause for reassessment.
Following a powerful three-month advance it is understandable that investors
with double digit paper profits are sensitive to any mention of a change to
the monetary environment.
If we are to make a judgement on the likelihood of when liquidity will be normalised, it is perhaps useful to have a way of measuring it. I thought it would be timely to review such measures.
The Federal Bank Total Assets Index ranged for much of 2011 and early 2012 but began to trend higher from September and was still hitting new highs at the last update on February 13 th .
The TED spread which measures the premium banks pay to borrow over governments has contracted sharply over last two weeks to a new low of just over 17 basis points. The Eurozone equivalent has been hovering at 10 basis points for nearly six months.
The Yield Curve spread hit a medium-term low in July and continues to rebound suggesting that the risk free premium of borrowing short-term and lending longer term is becoming increasingly profitable.
Since these measures do not appear to suggest that liquidity is in fact being withdrawn might we look elsewhere for a motivating cause for investor anxiety? Certainly the Fed minutes suggest that the removal of QE is at least a conversation piece for the Fed but the pace of Fed purchases remains unchanged. Another consideration is that the March 1st date for automatic spending cuts remains, so far, on track. While $85 billion in cuts is a paltry figure relative to the size of the budget it does represent uncertainty. This may be contributing to the desire of investors to lock in profits. China's efforts to rein property market speculation might also be a motivating factor.
Another way of looking at this question would be to address the performance of sectors which monetary easing is designed to support most; housing and banking.
US Homebuilders broke out of their bases more than a year ago and have led the improvement in perceptions regarding the housing market. The sector pulled back sharply yesterday suggesting a process of mean reversion is underway.
Banks represented the epicentre of risk prior to the financial crisis and a significant number of measures adopted subsequently were aimed at ensuring the sector's survival. The S&P500 Banks Index has been trading in the region of the upper side of its three-year range since early January and will need to hold above the 150 area on the current reaction if recovery potential is to continue to be given the benefit of the doubt. The S&P500 Diversified Financials Index is somewhat overextended relative to the 200-day MA as its tests the upper side of its 3-year range but has a similar pattern overall.
The Euro Stoxx Banks Index extended its pullback today and will also need to find support in the region of the MA if recovery potential is to remain credible. The FTSE-350 Banks Index, which has rallied so impressively since November continues to hold a progression of higher reaction lows but mean reversion is becoming increasingly likely.
These indices suggest short-term overbought conditions are being unwound following a persistent advance. A swifter reaction cannot be ruled out as this process of consolidation matures but so far there is little evidence to suggest that anything more than a reversion towards the mean is underway.