How Low Interest Rates Could Ignite a Market Rally
“To say there’s an inflation problem doesn’t mean double-digits here we come – it might just mean that we get to 2.5% or 3% in an environment where [interest] rates are zero and the Fed is printing money. That’s toxic.”
– Jim Bianco, CMT, in an interview with TrimTabs Research
As traders, it’s important to think in context of the big picture. Today, with the slow July Fourth trading week behind us, I want to show you how a big macro factor (interest rates) is going to be affecting the market this month…
So it happened.
Last week’s rate cut from the European Central Bank pushed deposit rates to zero, sending investors fleeing from euro-denominated bank accounts. Yes, you read that right – bank accounts in the EU now officially pay you zero.
Of course, it’s actually worse than that. The ECB’s deposit rate isn’t the rate that gets paid to savers, it’s the rate that the ECB pays to banks in the eurozone. Those low rates spread like wildfire across the eurzone — two-year yields in Germany, for instance, are actually negative right now, meaning that investors literally have to pay Germany to hold onto their money.
As a result, the big global financial institutions are shuttering their eurozone money market businesses. JPMorgan closed theirs to new investors. Goldman too.
They just don’t know how to manage super-low-risk funds when the powers that be decide to stop paying interest. And I don’t blame them.
If that scenario sounds foreign, think again. While rates here in the U.S. are higher, they’re not much higher – and with inflation well above 2%, we’ve still got a toxic environment for savers. And the consequences reach all the way into the stock market.
I’ve said before that all markets are connected. In other words, when investors decide to get rid of risk and buy treasury bonds, for instance, that money has to come from somewhere — that somewhere is stocks. That’s why stocks and treasuries have had a negative correlation since the start of the financial crisis.
So, what does it all mean for stock investors?
In short, it means that the bearish trade is continuing to pile up, adding fuel to the contrarian signals that we’ve been tallying for the last few weeks. The bearish side of the market is getting crowded on a historic scale, and that’s a good sign that we’re reaching a turning point for stocks. Eventually, return-hungry investors are going to have to turn to stocks to prevent their accounts from atrophying to nothing at the hands of the Fed’s targeted inflation rate.
And the timing is good too…
Earnings season officially kicks off today, with firms delivering a dump truck load of financial data to Wall Street. Analysts are already expecting the worst for the second quarter, so any positive surprise has the potential to squeeze investors back into stocks in this low interest rate environment. That’s why you should be keeping a close eye on Mr. Market this month.
If earnings look good, a rally could happen quickly…
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