Source: Zero Hedge
There are definitely signs that animal spirits are returning. Earlier in the week, the VIX made a five-year low. When you think about the levels of fear in markets back in October, it’s a remarkable recovery. A lot of people, myself included, underestimated the impact of the ECB’s LTRO. By backstopping the funding requirements of the Eurozone’s banks for a couple of years, the ECB has removed the immediate threat of more Dexia type liquidity/solvency crises for a while. It’s open to question as to how long this palliative will last, especially as Germany is getting more vociferous in its opposition to further tranches of central banks funding.
Source: Zero Hedge
This has all been a pleasant surprise to investors, but an excessively low VIX is also a warning. The chart above illustrates that it can be a precursor to a sharp rise in volatility and a fall in the equity market. Equally, however, there can be extended periods of quiescent volatility. It seems to me that economic indicators may supply support to markets for a while longer. In the US recovery does seem to be gaining some traction and the resumption of borrowing by the economy overall is a sign of returning confidence. I think it’s also likely that eurozone indicators could surprise on the upside, now that the immediate crisis has been dampened down.
Source: Global Economic Trend Analysis
Bond yields in the US have started to rise. If banks really are cashing out on their profits from Operation Twist, then the money will flow back into the real economy, unless the Fed decide to start unwinding its balance sheet. I would be really surprised if the Fed started selling assets back into the market to extinguish bank reserves, so it seems likely that any rise in bond yields, as long as it is modest, will bring a stimulus to economic activity and should be welcomed.
The gazillion dollar question for the Fed is whether the money multiplier comes back into play. If banks start to multiply aggressively reserves held at the Fed, it will be presented with a huge policy dilemma. However, I think it unlikely that this will happen. The recent stress tests show that a number of banks are somewhat borderline, despite only four failing. The announcement that JPM is raising its dividend and buying back stock, suggests that banks are not about to apply aggressively capital or reserves to lending.
One little aside is that Mr Dimon must have mightily upset the Fed with his arrogant pre-empting of the results of the stress test. To me it seems like a pretty foolish move to antagonise your regulator needlessly. Dimon has put JPM in a potentially perilous position if it ever needs favours from the Fed. One reason why Bear Stearns was allowed to go under was long memories from its intransigence on the LTCM rescue. Remember hubris, Mr Dimon.
lemmings can teach nothing 