Weekly Market Update: January 25th 2016

Market Recap

After a difficult start to the week, most of the major equity indices ended the week in positive territory. As expected, ‘Super Mario’ Draghi came to the rescue for markets with reassuring comments that fuelled hope of more aggressive monetary policy from the European Central Bank. The mere mention that additional measures will be considered at their meeting in March was enough to drive equity markets sharply higher on Thursday and Friday. This is a familiar story.

Adding to positive sentiment in equity markets was the surge in oil prices, helping lift energy shares that have been languishing in the doldrums. The only real catalyst in sight for oil prices to move higher, a short squeeze on speculators, came in the form of “Superstorm Sandy”, which hit the US East Coast last week. As traders moved to reverse short positions (bets on prices falling), referred to as short covering, prices spiked higher. US oil futures for March delivery jumped +13.5% on Thursday and Friday.

Super Mario inspired rally, but China risk remains….

In Europe, shares took off on Thursday following Draghi’s comments, which followed into Friday. The German DAX index ended the week up +2.30%, with the French CAC 40 index and the UK’S FTSE 100 index rose +3.01% and +1.66% respectively. In the US, the S&P 500 index is up +1.41% while the tech-heavy NASDAQ Composite has rebounded +2.29%.In Asia, Japan’s Nikkei 225 index surged +5.88% on Friday. Still, the index ended the week down -1.10%, which illustrates just how bad the week might have looked without the Draghi inspired rally.

At the World Economic Forum in Davos, world leaders reiterated their confidence that China does not face a hard landing. This makes me very concerned. Bank of Japan Governor, Haruhiko Kuroda, advised that China should impose capital controls to manage the exchange rate. Given the rate the Chinese are burning through their foreign exchange reserves to defend the Yuan, down $513 billion in 2015, capital controls may be needed. But China taking advice from the Japanese would be like Ireland taking advice from England on how to celebrate the 1916 Centenary. While the market rally last week is welcome China still remains a huge risk.

ECB Press Conference: Draghi quotes himself again….

This is the key excerpt from Draghi’s press conference on Thursday:

Question: You said in your opening statement that you could possibly reconsider the monetary policy stance as soon as March. What measures do you still have left, and what do you think they can do if these downside risks do materialise?

Draghi: As far as your first question is concerned, let me just recall my speech in New York, which was actually quoted during our discussion today, saying that, first of all, we have the power, the willingness and the determination to act. There are no limits to how far we are willing to deploy our instruments within our mandate to achieve our objective of a rate of inflation which is below but close to 2%.

So there shouldn’t be any doubt about that, and we have plenty of instruments, as you know. We didn’t want to discuss today the specifics of the instruments, but rather to determine and assess the stance that we may have to take in March. Here I’ll read again these quite important words: “It will therefore be necessary to review and possibly reconsider our monetary policy stance at our next meeting in early March, when the new projections will become available.”‘

Week Ahead

European equities are marginally in the read this morning despite a positive session in Asia overnight. The German IFO Business Climate Index for January, released this morning, missed expectations and dropped to an 11-month low, a reminder of the real concerns simmering over the underlying economic fundamentals.

Key macro data this week includes the initial estimate of fourth quarter GDP from the US and the UK. There are also a host of consumer and business confidence surveys from Europe and the UK, useful leading indicators on the economy. The preliminary January reading for inflation in Europe will be in focus as deflation risk has come back to the fore.

On the central bank front, the monetary policy meetings at the Bank of Japan and the US Federal Reserve will be keenly watched. No change in policy is expected from the Fed but investors will be looking for any hints on just how ‘gradual’ rate hikes will be. Speculation has been mounting that the Bank of Japan will pursue more aggressive easing and such an announcement on Friday would have markets salivating with another end of week rally.