Why the rally today?
Why are we seeing this rally today? Well, aside from some of the positive economic news regarding higher then expected sales of US existing homes, as well as new job hires there was a significant policy move by five central banks, including the Fed, Europe Central Bank, Bank of Japan, Bank of England and Swiss National Bank to help financial institutions obtain liquidity in times of crisis.
Essentially, a country’s central bank provides liquidity to major financial institutions (preferred institutions). Currently, the central banks have put a coordinated program in place that allows major financial institutions (if the bank qualifies under the terms of the program) to get access to additional short-term loans in times of crisis. So, if the private bank’ balance sheet takes a hit, due to unforeseen drops in values of its assets or holdings, well, they can bolster their balance sheet by taking a short-term loan from one of the central banks. The cost of those loans just got cheaper and the window for which they can get those loans is now open longer (until early 2013), per the news released today.
In addition, most financial institutions have obligations (loans that need to be repaid) that are in dollars. So, its important for them to be not only be able to borrow cheaply in times of crisis, but they need to be able to borrow “dollars” cheaply in times of crisis, because that is the currency creditors are expecting to get paid in. Although this program is also letting them get funding in any currency, if they need to, through a temporary special program. Seems mundane, but does make it less costly to meet their liquidity needs in a volatile market.
In the end, its a very cheap pay-day loan, should a bank need it. The move today was to preempt a “deterioration” of liquidity amongst financial institutions (think Lehman back in 2008), should Europe’s sovereign debt woes start to spread to the financial sector.