A CHANGE OF FORTUNES FOR RISK ASSETS

 
David Morris
WHAT a turnaround last week. We saw an extraordinary rally in equity markets which saw them recoup the losses from the sell-off that had persisted through much of November. Personally, I believed that the major stock indices were on the point of a major break to the downside which would only be averted by a drastic change in behaviour from European policymakers. As this looked unlikely, I was convinced that risk markets would deteriorate further before they got better.

But while Eurozone leaders bickered amongst themselves and the ECB insisted that it would not become the lender of last resort to troubled countries, there were other moves afoot. On Wednesday morning, the People’s Bank of China (PBOC) cut its required reserve ratio for banks by 50 basis points. This was quickly followed by the news that the US Federal Reserve, together with the Banks of England, Japan, Canada, the ECB and the Swiss National Bank reduced the interest rate on overnight dollar swaps. With China’s manufacturing sector contracting rapidly, many analysts now believe that the PBOC will loosen monetary policy further. While this is possible, there is still a substantial risk that inflation could pick up again, something that the Chinese authorities will want to avoid at all costs. The cut in the dollar swap rate cheered investors as it convinced them that central banks were working together and taking action to improve liquidity to financial institutions. The hope is that this example of cooperation may rub off on policymakers in Europe and the US.

The net effect was that risk assets soared, while the dollar fell sharply. The FTSE 100 now appears to have built a base around 5,500 and on Friday it tested resistance at 5,600. This marks the 61.8 per cent Fibonacci retracement of the May/October sell-off earlier this year. A break above here suggests that a test of the 200-day moving average at 5,640 is on the cards, although cautious traders will be wary of taking on too much exposure given the speed of last week’s rally. In the US, the S&P 500 tested its own 200-day moving average at 1,262. US data has improved to some extent, but it is the EU summit on Friday that is now crucial.