DE30: Draghi tests legal limits for QE flexibility

Summary:

• European stock markets open lower on Wednesday after mixed trading in Asia
• Mario Draghi tests legal boundaries for quantitative easing
• DAX breaks below the important technical support

The start to Wednesday's trading has not been successful despite some encouraging comments brought by Bloomberg that the US seems to be willing to suspend another round of tariffs against China (on goods worth $300 billion). However, sentiment was not upbeat in Asia as well where Chinese indices finished the day pretty flat while the Japanese NIKKEI closed 0.5% down. Looking forward one may suppose that equity investors could struggle to find strong reasons to justify the current valuation of stocks in Europe or in the United States. The economic outlook has dimmed of late and major central banks have begun talking about the need to make monetary policy more expansionary. We doubt that any rate decreases will boost equities in a sustainable manner if a real economic downturn actually arrives.

The ECB has injected lots of liquidity into the banking sector in recent years. Source: Bloomberg

Focusing on two major central banks - the Federal Reserve and the European Central bank - it is worth mentioning a Bloomberg article touching on a QE program in the Eurozone. It says that Mario Draghi is again testing the legal boundaries for its quantitative easing program. Let us recall that he turned on the light green for further monetary easing last week during his speech in Sintra. ECB’s Governor suggested then that if the economic outlook did not improve, the ECB stood ready to act by either cutting rates or relaunching its large-scale purchases of government bonds. Thus, in practice Mario Draghi decided to renew his “whatever it takes” pledge from 2012. Where is a possible legal hurdle localized? Within its first round of outright government bond purchases, that ended in December 2018, the ECB agreed to buy up to 33% of a nation’s public debt and up to 50% of debt owned by supranational institutions like the European Investment Bank. The problem here is the fact that the ECB has already pumped lots of liquidity into the money market, as evidenced by the chart presenting excess liquidity, hence if it keeps its 33% limit it could not leave much space to stimulate the economy in such a manner. The possibility to deal with this issue is to raise the limit to 50% which, as the article says, would enable the ECB to buy 60 billion EUR of bonds per month for two years. However, it cannot be as simple as it seems due to a possible legal challenge from the European Court of Justice, let alone a German court that has yet to issue a verdict (Germany has accused the ECB’s QE of printing money to fund governments).

Technically the DE30 moved below its 60MA (H4) on Tuesday. Notice that the line provided a support for buyers earlier this month, hence in theory it could signal more downside ahead. In this regard, today’s session could be critical and if the price fails to get back above this line again, sellers may try to take control. Source: xStation5

Looking into the DE30 breakdown one may notice that Thyssenkrupp is standing out the most being more than 5% up at the time of writing. It is a result of the report released on Tuesday that Kone, an international engineering and service company headquartered in Finland, may be preparing an offer for Thyssenkrupp’s elevator business. So far we have not got any confirmation either from Kone or Thyssenkrupp. 

Apart from the story above, it is also worth mentioning Adidas whose shares are gaining over 3% today. This outperformance could be tied to a Goldman Sachs recommendation where the bank raised its price target to 310 EUR over the next 12 months. The spot price is 272 EUR.

Thyssenkrupp and Adidias are leading the gains within the DE30 on Wednesday. Source: Bloomberg