Stock Market Watch

Stocks Rise on Central Bank Action

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Stocks surged more than 4 percent on Wednesday after major central banks agreed to make cheaper dollar loans for struggling European banks to prevent the euro-zone debt crisis from spiking a credit crunch.  This coordinated move by the major central banks added liquidity to the world’s financial system, easing worries about a global downturn.

The U.S. Federal Reserve and the European Central Bank as well as the central banks of Canada, Britain, Japan and Switzerland agreed to lower the cost of existing dollar swap lines — reducing the cost of temporary dollar loans to banks — by half a percentage point. The central banks’ actions were intended to ensure that European banks, facing a credit crunch, have enough funding amid the euro zone’s worsening sovereign debt crisis.
The moves followed an unexpected cut in bank reserve requirements in China, intended to boost an economy running at its weakest pace since 2009.

Financial, energy, materials and industrial stocks, among those seen most economically sensitive, led gains, though all S&P 500 sectors rose. Bank of America Corp (BAC:NYSE)  rose 2.76 percent to $5.21 after hitting a near 3-year low, while JPMorgan Chase & Co (JPM:NYSE) added 6.58 percent to $30.44.


Based on the latest available data, the Dow Jones industrial average jumped 490.05 points, or 4.24 percent, to close unofficially at 12,045.68. The S&P 500 rallied 51.77 points, or 4.33 percent, to close unofficially at 1,246.96. The Nasdaq Composite gained 104.83 points, or 4.17 percent, to end unofficially at 2,620.34.Copper and oil futures also rose sharply.
The S&P materials sector index .GSPM gained 4.5 percent.

The attempt by major central banks to ease strains on Europe’s credit markets definately encouraged financial markets on Wednesday, but what does the joint action actually do?

In short, the US central bank, or Federal Reserve, agreed to provide cheaper dollar funding to the European Central Bank, allowing the ECB to then provide cheaper dollar loans to cash-strapped European banks.
The joint participation of the central banks of Canada, England, Japan and Switzerland is more of an effort to show that all the central bankers are making a concerted effort than any expectation that there will be lots of dollar borrowings.
The ultimate goal is to ease the credit crunch in Europe. Many European banks make dollar denominated loans, in part because US interest rates are so low. The banks do not usually finance these loans in the way familiar to most—by lending out the deposits of their retail customers. Instead, the loans are financed by short-term borrowings from other financial institutions.
When European banks make a dollar loan or purchase a dollar denominated asset, they usually borrow the dollars on the what’s called “international wholesale deposit market”—which is a term for borrowing from other banks that have dollars. Alternatively, they can borrow in their native currency and then use foreign exchange swaps to hedge the currency risk.

Now that Europe is in the throes of a debt crisis, it has become much more difficult for many European banks to borrow dollars in the wholesale markets. To make dollar loans, then, they have to turn to the European Central Bank. Moereover, the cost of the foreign exchange swaps has increased, making it more expensive to make dollar loans based on euro assets.

Under normal circumstances, central banks only make loans in their domestic currencies. But in times of international stress—the credit crisis of 2008, for instance—central banks around the world set up swap lines that allow them to borrow from each other, creating the ability for them to make loans in other currencies.
In short, European banks were finding it too expensive to make dollar loans, which hurt their ability to lend dollars and encouraged them to sell euros. This depressed the value of the euro and restricted credit in Europe. The ECB arranged to borrow dollars more cheaply from the Fed, so it could ease this market.

Further encouraging investors, the latest U.S. data suggested the U.S. economy was moving more solidly toward recovery. The U.S. private sector added the most jobs in nearly a year in November, while business activity in the U.S. Midwest grew faster than expected in November.
For November, the Dow edged up 0.76 percent, but the S&P fell 0.50 percent and the Nasdaq Composite dropped 2.39 percent.

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Post Written By: Meggan


Ed Liston

Ed Liston is a senior contributing editor at TheStockMarketWatch.com. An active market watcher and investor, Ed guides an independent team of experienced analysts and writes for multiple stock trader publications. He is widely quoted in various financial publications on the Internet. When Ed is not writing about stocks, investing in stocks, talking about stocks, or otherwise doing something stock related, he likes to go sailing and fishing.

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