Equities Edge Higher On QE Addiction—What If The ECB Does Not Deliver?

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[Chart courtesy of MarketWatch.com]

US equities surged higher Tuesday, extending gains for the third straight day with the S&P 500 clipping the 1,400 mark and the NASDAQ sitting atop 3,000 for the first time in three months on hopes the European Central Bank will intervene soon to halt rising Spanish and Italian borrowing costs.

Let me be clear again. Markets are hovering only at these levels because a total QE package has been priced in; not just in Europe but in the US as well. If this does not come to pass quickly, there is bound to be a sharp trend reversal forthcoming as no improvement in fundamentals has played a role in this rally, but merely QE addiction.

As a result, European stocks traded higher as markets continued to bet that Spain will request a full-blown bailout soon, potentially clearing the way for the region’s yet to be established/funded bailout fund, the ESM, to obtain a banking license that will allow it to buy Spanish bonds from the secondary markets—at least that’s the hope, which has not yet received support from paymaster Germany.

The dollar index, a barometer of the greenback’s strength against six major rivals, traded slightly higher over late Monday’s 82.175 after risk appetite waned as the day wore on while the euro ticked lower.

Economic data from the Euro Zone however, remained sub par with UK manufacturing output shrinking 2.9 percent in June, the biggest drop since November 2008. German factory orders declined faster than expected at 1.7 percent in June while Italian GDP contracted 0.7 percent in the latest quarter after shrinking 0.8 percent in the prior quarter.

US Treasuries scaled back Tuesday as allure of safe-havens diminished, pushing yields to the highest level since early July as robust corporate earnings bolstered views European turmoil won’t slow down the alleged US recovery substantially. US exports to Europe may be dented by $5 billion, which is less than 1 percent in nominal terms for the GDP, according to economists.

As European equities rallied Tuesday, peripheral Europe-linked ETFs also surged, posting solid gains for the day. The iShares MSCI Spain Index Fund (EWP) rose 2.45 percent while the iShares MSCI Italy Index Fund (EWI) climbed 2.16 percent.

Surprisingly, Germany’s main opposition, the Social Democratic Party (SPD) argued for changes in the country’s constitution that would lead to stronger fiscal union across the eurozone, thus setting the stage for the eventual launch of Eurobonds. SPD’s suggestion, if implemented, will consolidate the process that Merkel approached in a piecemeal manner.

Of course, the jawboning will continue until some hard facts surface, such as Germany’s court ruling on the constitutionality of the ESM due out on September 12. Until that time, everything is merely speculation.

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