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Draghi Drags S&P 500 Over 2000; Potential ECB Easing Boosts Dollar

NEW YORK (TheStreet) -- On this Labor Day, European Central Bank President Mario Draghi is doing the heavy lifting for the S&P 500 (SPY) . The ECB, not the Federal Reserve, is currently the central bank pushing investors into riskier bets in the U.S. stock and U.S. bond markets. The ECB currency countries constitute the largest economy in the world. A substantial bond buying program from the ECB will boost the dollar further along with the prices of all U.S. assets, including U.S. stocks.

The Federal Reserve's third bond buying program or quantitative easing (QE3) has been much maligned for driving investors into riskier sectors such as the stock market, SPY, (VOO) , (IVV)   and (DIA) . Yet, with the QE3 tapered out, guesses for the start of Fed funds interest rate hikes center around mid-2015. That means the Fed is starting to put the brakes on speculation. U.S. data on unemployment, corporate earnings and growth show a recovery in the U.S. in full swing, and stock prices are reflecting that. Thus, the Fed will be forced to raise rates sooner rather than later, which should be pushing up U.S. Treasury yields. But Treasury yields fell in August and Treasury bonds, (IEF) or (VGIT) , have been rallying. At the end of August, it was the potential of more monetary stimulus  from the ECB that was driving U.S. bond prices higher.

Europe is still mired in a debt-deflationary spiral. Unemployment rates top out above 20% in many member states in the eurozone, and the overleveraged banks refuse to lend. Draghi hinted at more stimulus at the central banker's conference at Jackson Hole, Wyoming, recently. Draghi has talked tough before and failed to act. Nevertheless, it finally seems as though the ECB has no choice but to flood the world with euros to prevent deflation.

The last time the S&P 500 first crossed a thousand-point threshold was in 1998 during the Asian crises. In that year, the dollar rallied because of devaluations and weakness in Asia. Investors fled to U.S. markets for safety in 1998. Today, European investors are moving to the U.S. for better yields and have helped boost the S&P 500 index past the 2000-point mark in August. In 1998 as today, the Fed faced little inflationary pressure to raise rates at a faster clip, due in part to the dollar rally.

German bonds are the only large safe haven in the euro currency zone. In the last week of August, German 10-year government bonds (bunds) yielded a measly 0.9% while investors could get more than 2.3% yield on the U.S. ten year Treasury. The low bund yields likely reflect both deflationary expectations in Europe and the anticipation of an ECB bond buying program. Either scenario justifies minuscule German bund yields. These low bund yields are spurring the flow of cash out of Europe. That flow makes the dollar more valuable and also moderates U.S. import price inflation. Both the reduced import price inflation pressure and increase in demand for Treasuries pushes down yields and boosts prices of U.S. government bonds. Thus, it seems for now, the U.S. Treasury market can defy the logic that interest rates have nowhere to go but up.

At the time of publication, the author was long SPY and VOO.

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SPY $210.82 0.02%
DIA $177.29 0.02%
IEF $105.82 0.11%
VGIT $64.64 0.00%
VOO $193.28 0.02%


Chart of I:DJI
DOW 17,745.98 -5.41 -0.03%
S&P 500 2,108.63 +0.06 0.00%
NASDAQ 5,128.7850 +17.0520 0.33%

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