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How close were we to a credit disaster last week?
I was surprised by last week’s announcement by the major central banks to pump liquidity into the global financial system so I spent a fair bit of time on the weekend researching to find out the reason behind this unexpected move. While it is common knowledge that European banks were experiencing an onset of a credit crunch, I don’t think anyone really thought things were that bad to require not just one but six central banks to intervene. Perhaps the European Central Bank has already shot their “bazooka” in previous announcements and now need help from other central banks to create more “shock and awe” to help markets regain confidence. Some blogs have reported rumours that a major European bank was about to collapse last week so this liquidity measure was to prevent another 2008 style credit disaster which was sparked off by the collapse of Lehman Brothers. I guess we will never know how close we came to the brink of another credit disaster last week.
This announcement caught many traders off guard so the initial reaction is of course to cover any short positions which resulted in a massive rally on Wednesday. As market participants had more time to digest this, I think many are coming to the conclusion that things may be worse than we thought and euphoria had given way to caution by Friday. The major US indexes had an early pop (thanks to an unemployment number of below 9%) which fizzled throughout the day resulting in a gravestone doji pattern on the daily charts as shown below of the S&P 500 index. This pattern frequently reflects the exhaustion of an uptrend, like what we saw in September.
While the chart pattern in stocks is still inconclusive, the picture in currencies is clearer. The US dollar index ($DXY) which has been in an uptrend since September only fell 1% (compared to the 5% up move in stocks) after the Nov 30 announcement and most of this move has already been retraced as shown by the big bullish candle on Friday in the chart below. The flight to safety trend is still very much intact.
December is normally a bullish month and the rally could continue to year end. However, I have not found enough reason to close my bearish bets yet.
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