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Another week begins, and the QE-illusions of grandeur remain dominant across the global financial markets. After Janet Yellen told the Senate Banking Committee  on Thursday  that the American economy continues to operate well below potential, investors have pushed taper expectations out to next year and the world’s most influential stock indices are trading at historic highs. Both the S&P 500 and the Dow Jones Industrial Average are sitting atop six straight weeks of gains, and risk-sensitive currencies are up sharply.

Adding to the sense of optimism, Chinese policymakers announced a raft of reforms over the weekend that are widely expected to put the globe’s second largest economy on the path toward sustainability. According to a document prepared by the Central Party Committee, rural land rights are to be strengthened, the one child policy will be relaxed, and the ‘hukou’ system of household registration will be overhauled. Financially speaking, interest rates and the capital account will be liberalised, the renminbi will trade more flexibly, and factor prices will be determined by market forces rather than political considerations.  

These measures are forecast to reduce some of the major imbalances currently afflicting the Chinese economy, while retaining many of the features that have supported growth so well in recent years. As has been the case since the seventies, the document charts a path that Deng Xiaoping memorably described as “crossing the river by feeling for the stones” – making incremental changes without endangering the broader economy. Overall, the odds of a hard landing have diminished sharply, and scepticism is falling across the financial markets.

Somewhat surprisingly, the Canadian dollar is only marginally higher, up less than half a cent against the greenback. Years of poor productivity growth appear to be taking their toll on the currency, with traders positioning for a widening performance gap against the United States.  With commodity prices on a slippery slope, very few investors are willing to take heavy positions on the long side of the loonie, and 1.0500 looms as a critical target for many market participants.

Over the week ahead, the only major catalyst for trading appears to be Wednesday’s release of the Federal Reserve’s meeting minutes. In the event that wide differences are evident among committee members, today’s positive sentiment may be dampened somewhat – but this appears unlikely. However, as we’ve warned repeatedly, the market’s current insensitivity to economic data is worrisome. Only releases that might have an impact on the monetary stimulus programme are being treated with any seriousness, and liquidity conditions appear to be the only major driving force behind price movements. We fear that the reaction will be violent when this effect begins to wear off in the New Year, meaning that companies should use this period of low volatility to build out hedging strategies that can withstand the inevitable hangover.  

Further reading:

EURUSD Approaching Resistance Zone (Elliott Wave Analysis)

Janet Yellen’s speech pushes indices to new highs; What to expect this week?