SPY

Global risk assets have rallied over the past couple days off remarks by European Central Bank president Mario Draghi that the ECB is ready to enact any measures in order to preserve the euro. Investors have been speculating that the ECB will initiate a form of quantitative easing in Europe. The ECB would be buying European assets, such as Spanish/Italian sovereign bonds and corporate bonds of companies in financial distress, via the European Stability Mechanism (ESM). The ECB would be lending money to the ESM, which would use this "printed money" to buy assets and then use these assets as collateral in a repo with the ECB. In effect, the European Central Bank is printing money and pumping it into the system. Were this to in effect take place, one would expect global risk assets to further rally. Since the ECB would be "printing" euros, this "solution" to the European debt crisis would further weaken the euro over the long-term. With markets discounting that world central banks will be announcing new measures this week. The US Fed will be meeting this week (FOMC meeting today and tomorrow). The Bank of England (BoE) and the ECB are also to meet this week. While investors expect the ECB to announce their version of QE, many anticipate that the Fed will be moving the IOER (interest on excess reservers) to 0% from 0.25%, with the hope of "forcing" banks to lend out the excess liquidity they hold above their capital requirements. With investors having such expectations going into the meetings this week, markets have factored in the possibility of these new economic measures going into effect. Were policymakers to disappoint and no new measures announced, expect the markets to sell off sharply.  With such macro uncertainty (European debt crisis, potential Chinese slowdown, and US fiscal cliff) it seems smart to take profits at these levels in the market and to have a cautious outlook. This risk underweight thesis would only be changed by new policy measures effectively being announced this week or in coming months. However, there is no reason to be very bullish at these levels and with the current economic context.

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