PBOC Feeds Policy Stimulus Fever

Originally posted at Briefing.com

Everything is right with the equity market world—or so it seems. Since its low on September 29, the S&P 500 has surged 9.7% and it's coming back for more today. Currently, the S&P futures are up 16 points and are trading 1.2% above fair value.

The catalysts for the bullish bias are easy to identify today. Alphabet (GOOG), Amazon.com (AMZN), and Microsoft (MSFT) all knocked the cover off the ball with their third quarter earnings reports. That fueled a justifiable charge in the Nasdaq 100 futures and helped reinforce the bullish orientation of Thursday's somewhat outlandish rally.

To wit, the stock market took off on Thursday reportedly because European Central Bank President Draghi hinted at the prospect of providing additional policy accommodation before the end of the year. We were struck by the extent of the gains for two reasons: (1) the talk ahead of the meeting is that he would offer such a hint, so it wasn't a surprise that he did and (2) the market didn't seem to hone in on the fact that the basis for adding more accommodation is a weak economic outlook.

Alas, the stock market went right to its happy place of trading the policy line and looked to completely ignore the fundamental message of Draghi's remarks. Actually, what we think the market did was put its own fundamental spin on those remarks.

Specifically, it bought into the view that more policy accommodation will lead to stronger real economic growth and stronger earnings growth six months down the road. Lo and behold, it was the industrials (+2.8%) and materials (+2.8%) sectors that were the best performers on Thursday, never mind that Caterpillar (CAT) and Freeport McMoRan (FCX) both checked in with some disappointing results and guidance that didn't exactly scream demand improvement.

Today, the market will be dealing with a similar policy line, only this time it doesn't have to cross any thought lines. The People's Bank of China (PBOC) didn't hint at more policy stimulus, it actually provided it.

After markets in Asia closed for trading today, the PBOC announced a 25 basis point cut in its one-year lending rate to 4.35%, a 25 basis point cut in its one-year deposit rate to 1.50%, and a 50 basis point cut in the required reserve ratio for qualifying institutions.

The S&P futures spiked on the move, rallying around the accommodative message, which, like Mr. Draghi's view of things, was borne out of a womb of economic weakness.

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This is all doing wonders for the dollar, which soared yesterday against the euro and is also coming back for more today. Currently, the US Dollar Index is up 0.3% at 96.64.

That strength hasn't forced commodity prices lower—not yet anyway—and it hasn't caused emerging markets to unravel—not yet anyway.

Instead, all things seem to be copacetic—for now anyway—but recall that a strong dollar, which was fueled in part by policy path differentials between the Fed and other major central banks, caused a few problems for global markets back in August. That could happen again if these trends remain intact, yet short squeezes at the moment are probably delaying matters.

The risk-on trade is still on, and it is undercutting the Treasury market right now. The 10-yr note yield, which held up remarkably well during Thursday's stock market rally, is down 19 ticks at the moment, boosting its yield six basis points to 2.09%.

Frankly, there is a perfect mix today for risk-on behavior. Corporate earnings from index heavyweights were really good and the PBOC is providing added policy stimulus. It's almost too good to be true for the bulls, which may be why the market could ultimately disappoint today in the same way it pleasantly surprised after the lousy September employment report.

Recall the latter prompted a big selloff and then a huge reversal. Today it strikes us as possible that we could see a big gain followed by a profit-taking reversal from a short-term overbought market.

We're not banking on the idea, though, because this market is charged up with policy stimulus fever.

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