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A new wave of QE is on the way- will it all end in tears?

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Carlsquare
8 Feb 2021 | 5 min read
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It is well known that Quantitative Easing or QE becomes less and less effective each time it is used. A new abbreviation is now being used more and more frequently: YCC, which is to be interpreted as yield curve control. The central banks can control the short-term interest rate today by setting this interest rate and checking that everybody bought and sold in the market adhere to this interest rate.

It is well known that Quantitative Easing or QE becomes less and less effective each time it is used. A new abbreviation is now being used more and more frequently: YCC, which is to be interpreted as yield curve control. The central banks can control the short-term interest rate today by setting this interest rate and checking that everybody bought and sold in the market adhere to this interest rate. Now that speculation about rising inflation is picking up, long-term interest rate is starting to rise. These interest rates cannot be controlled by the central banks today. The purpose of the YCC is precisely to take power over this market as well.

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In Japan, which is 20 years ahead of the United States and Europe when dealing with bubbles, every conceivable attempt to speed up the economy has been used. In 2016, Japan introduced the new YCC policy and simply locked in the ten-year interest rate to 0 percent. What has happened since then is that there is only one buyer in the market of all bonds issued by the state and that is the central bank. In his latest weekly letter, John Mauldin highlights this debate. When that kind of discussion reaches him, it is a clear sign that it is spreading in well-established circles.

The YCC provides governments and central banks with an almost infinite resource to create more money that can finance budget deficits. Usually, it is the fixed income market that keeps excessively generous states in discipline and admonitions and dump their bonds, causing interest rates to skyrocket. Rapidly rising interest rates paralyze the economy and quickly overthrow the incumbent government. If it does not happen immediately, it will occur when inflation goes through the ceiling.

But what if the central bank in the same country acquires all the bonds? Yes, we can read that from what has happened in Japan. The central bank fails in accelerating economic growth, but there will also be no collapse of the system. There can be no crash because the central bank BOJ soon own almost all outstanding bonds and has killed the entire market. There is simply no functioning fixed income market left as there is only one seller (the state) and one buyer (Bank of Japan, BOJ).

Look at the chart above. This distorted market has now been going on since 2016 without any major crash. It is obvious that the states see this as a possible continued way forward. Mario Draghi made himself famous historically by defending the Euro in the crisis in July 2012 by saying that “the ECB is ready to do whatever it takes”, which succeeded.

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The same Mario Draghi now has good opportunities to become Prime Minister of Italy. If there is any country that currently needs continued support in the fixed income market, it is the heavily indebted Italy. If Draghi gets the chance to form a government in Italy, then ECB chief Christine Lagarde will be one of the first on his call list (if she does not have time to call him first to gratulate).

It is all reminiscent of the pig Särimner who was slaughtered every day at the Nordic feasts, to be resurrected the next day. It was a convenient invention for the Asa Gods, but it could not last forever. It simply ended when the Nordic people stopped believing in the Asa religion, who in Iceland was replaced by Christianity via a district court decision in year 1000. In the same way it will go with the YCC. It will work if we believe in the government and the central banks. The growing polarization in society, as well as the storming of the US congress, are signs that the current situation will not last forever. But to guess when the current trend is broken, there is no point in doing so. It is just a matter of being aware of the opportunities and risks, and to act accordingly. Stay tuned and be prepared to exit the market!

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Above is the recurring chart that shows the correlation between the S&P500 index and the support purchases from the Federal Reserve.

The Q4 2020 reporting season in the US and Sweden

During the past week, another 110 S&P500 companies reported their Q4 2020 results, which means that 58 percent of the companies have reported their figures so far. 84 percent of companies’ result are better than forecast, while 78 percent are in terms of revenue. The best sector is Technology with 94 percent of the results above forecast, followed by Health Care with 89 percent and Industrial companies with 85 percent positive profit surprises.

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We also had an unexpectedly good outcome on the Stockholm Stock Exchange with 79 percent (19 out of 24) companies in the OMX30 index that managed to exceed the earnings forecasts. It is worse on the revenue side with only 58 percent better than expected. The SEK strengthening probably plays a role here, with negative currency translation effects. The result can, however, be currency hedged 3-6 months ahead. Possibly it is also a sign that companies have been good at lowering their cost base, which has given a better result despite lower revenues than anticipated.

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Momentum

The risk appetite is back. The S&P500 index is steadily trotting further upwards. The Reddit uprising is forgotten. The hedge funds have quickly adjusted down their short positions so as not to be exposed once again.

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The 2-hour graph shows how the S&P500 index bounced on the MA200 as a support. Will the index be able to break through the wedge-formation?

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The US tech sector is leading the price rise. Below is the daily chart for Nasdaq. As can be seen all MA lines have been recaptured. But on Friday, a scary looking doji was created around the ceiling of the rising trend channel:

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It is unusual to see a large company like Microsoft with such a clear momentum for the stock. Note also how the wedge-formation calls for further upside – is it an opportunity to buy the dips?...or will the negative divergence between RSI and the share price take out its rights?

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The Amazon stock tested a previous resistance that now constitutes a support. EMA9 is still rising and the broken wedge-formation calls for further upside.

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The German DAX index has somewhat surprisingly placed itself in the lead among the larger global indices. A weaker Euro and new support may have had an effect. The DAX is now testing a previous top. Note how MACD has generated a weak buy signal, but also that a scary looking doji was created on Friday:

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OMXS30 was testing new highs on Friday but failed. Rising EMA9 and MA20 still supports the index from below. However, note that there is a scary looking negative divergence between the index and MACD. Maybe it is time to stay out until the negative divergence is broken?...or at least wait for a dip?

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The ECB has managed to talk the EUR/USD down to 1.20 against the USD again. Note however how the currency pair managed to bounce of the rising MA100 nicely. EMA9 and MA20 is still falling and putting pressure on the EUR/USD from above.

Despite a strong USD, Brent oil managed to close above MA200 in the weekly graph below. Is 65 USD/barrel next? Alternatively, will the stronger USD come in the way?

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Risks

This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capital protected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.

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