The market has been waiting for the update from the European Court of Justice (ECJ) on the potential legality of the ECB’s European Stability Mechanism (ESM) which would be supported by Outright Monetary Transactions (OMT). The ECJ ruling could have made it difficult for the ECB to ease monetary policy further if the ruling had suggested that the OMT was not legal. However, this morning, the ECJ advised in a non-binding ruling that the OMT may in fact be legal and was in line with EU law.
The ECJ whilst hardly being definitive has suggested that as long as there is no “direct” involvement in financing governments then the ECB can continue with its actions. This suggests participating in the primary bond markets will not be allowed, but acting in the secondary markets will be acceptable. This is what the OMT is set up to do anyway. So in effect it is as you were.
There is not a great deal that has been changed by this ruling as it was a recommendation and non-binding. This leaves the door open to future legal challenges but for now another hurdle that might have been in the way of implementing full blown Quantitative Easing has been removed. With the Eurozone now in deflation, and this ruling suggesting that the actions of the ECB are legal, the markets will now look to price in further monetary easing of sovereign debt asset purchases by the ECB. The stance of the Germans, most directly Jens Weidmann (President of the Bundesbank) and Wolfgang Schaeuble (German finance minister), very difficult now.
The expected reaction to this would be for the euro to sell off whilst the equity markets in the Eurozone (which are likely to indirectly benefit from sovereign debt purchases) would go up. This is exactly what has been playing out this morning.
We have seen the euro break below the support at $1.1752 and move to a new low dating back to November 2005. The selling pressure is likely to mount in the coming days with further downside towards the support at $1.1640 being the next target. Selling into rallies is likely to continue in the run up to the 22nd January when the ECB next meets to discuss monetary policy.
With regards to the DAX, it is an interestingly strong reaction today. Whilst just over 10% of the DAX is made up of basic materials stocks (a sector that has come under considerable pressure today due to the huge sell off in copper today), the reaction of the broad index has been positive. The index opened around 1.5% lower and has bounced strongly since the ECJ announcement and is currently off just 0.4% (having briefly traded in positive territory). Investor sentiment is terrible today and this suggests that in a favourable market environment, we can expect to see gains on the DAX as we approach the ECB meeting next week.
Furthermore, the technical outlook on the DAX is also improving. A recent break higher from a symmetrical triangle remains intact and this suggests that a retest of the all time high at 10093 can be expected. The caveat is whether the basic resources continue to be a major drag, however, that aside with QE firmly on the table and the technicals improving too, the DAX is set up for further upside.