Two key events pushed the market higher last week; an unexpectedly good domestic jobs number and the European Central Bank’s (ECB) decision to cut interest rates.
Surprisingly enough, the jobs number, while welcome news, took backstage. One would think that a six- year low in unemployment was a big deal. It is… but not as big of a deal as the ECB’s action. Because that has the potential to keep the bull market in stocks intact…at least for the time being.
Up until two weeks ago interest rates had enjoyed a steady climb from the 2012 lows. But last week that began to change for reasons I wrote about on Monday. Among the factors pushing down rates, the potential for the ECB interest rate cut was the lead story on Thursday.
ECB Interest Rate Cut
Well the ECB delivered, cutting its main lending rate to 0.15% from 0.25%. That’s a record low which should allow commercial banks in the euro zone to borrow more cheaply.
But it also lowered the overnight rate on bank deposits to negative 0.1%. That means commercial banks will have to pay the central bank to hold their money overnight. The goal here is to get these commercial banks to loan out more money instead of hoarding it themselves.
Remember when the U.S. Federal Reserve threw everything it had at the wall to stimulate the economy in 2008? Ultra-low lending rates and massive bond-buying programs helped light a fire under the market.
The main difference between what happened here then, and what’s happening in Europe now, is that the ECB is not kicking off a massive bond buying program. But that’s not off the table.
The ECB’s goal is largely the same as was the Federal Reserve’s; stimulate the economy, get money flowing to people who need it, and get people spending.
And the impact on stocks may be the same too. One might think that with global growth pitifully slow a slight change in interest rates wouldn’t amount to much. But the ECB’s actions show that it is, much like the U.S. was, committed to the cause of increasing liquidity to support growth. And that’s likely to support equity prices at the very least, and potentially push them higher.
While growth here in the U.S. is nothing to write home about, the Federal Reserve’s policies are largely credited with giving the economy the shot in the arm it needed to get going. The ECB is hoping for the same result overseas.
The potential issue is, of course, what happens when interest rates can’t go any lower? What if the intended growth doesn’t materialize? That would spell big trouble – likely in the form of a sustained recession which the ECB has fewer tools to deal with. Thankfully it hasn’t had to go as far as the U.S. had to so it still has some firepower left.
What’s really interesting about the ECB’s actions is that they fly in the face of those of the U.S. Federal Reserve’s right now. The Fed has been trying to pull back stimulus, while the ECB is just getting it going. As of right now the ECB appears to be winning the tug-of-war over control of the financial markets since interest rates have come down.
This may be just what the market needed to maintain momentum as we await next quarter’s earnings season. The underlying message the ECB is sending the market isn’t overwhelmingly positive given that it feels the need to juice its economy.
But still, investors don’t generally do well when they fight central banks. So for now, the best course of action is to stick with stocks.
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