The Short View: Market response to ECB move

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Sometimes a spasm in the market can almost be encouraging. That might just apply to European markets’ response to two scary headlines from Europe – that the European Central Bank was intervening to provide liquidity, and that BNP Paribas was freezing three of its investment funds to redemptions owing to what it called the “complete evaporation of liquidity” in US credit markets.

That should have been enough to bring back in full force the fears that the crunch in the credit market will turn into a full-blown financial meltdown.

But it did not. European equities had a thoroughly bad session, but never came close to their lows of a week ago, when they took fright from a similarly negative description of the market from Bear Stearns. US equities also held surprisingly firm – until a late sell-off set up what will be a tense opening on Friday in Europe.

Bond yields also fell, particularly in the US – as expected when investors need a haven – but remained above their lows of last week. The dollar gave up some of its initial gains against the euro.

More impressively, the ECB seems to have succeeded in making its rescue move without prejudicing the extremely hawkish message it sent to the market last week, when the bank virtually promised that it would raise rates next month. By the close, futures still priced in that increase. (This is not true of the Federal Reserve. According to Fed Funds futures, the chance of a rate cut in the next three months doubled on Thursday.)

So the ECB has persuaded traders that it is still committed to fighting inflation, in spite of flooding the market with liquidity. But it needs to remain a “one-off”. Traders may start betting against a rate rise next month if the ECB has to keep intervening. For now, the ECB can congratulate itself on some great financial gymnastics.

Now, on to the next scary headline.

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