How do you explain the recent uptrend in stock market (SPY) since mid-December 2012? I show that one of the key variables has been the expectation of an improved economic situation in the eurozone. Specifically, during the first week of Dec 2012, the EURIBOR futures have been predicting no change in the short term interest rates on the euro deposits from the current level of 25 basis points in June 2014 contract - meaning no expectation of better economic growth in the eurozone by June 2014.
By the end of January 2013, the expectations embedded in June 2014 contract have significantly improved by predicting that the ECB would raise interest rates to 75 basis points by June 2014. That was clearly an extremely bullish forecast for the eurozone economies, perhaps an overly bullish expectation. The current expectation embedded in the EURIBOR futures is 50 basis points by June 2014, thus, the expectations have been somewhat reduced, but still bullish. As a result, the stock market has been reluctantly rising in February, and now correcting, possibly reflecting the downgrade in the eurozone. See Figure 1 for data on June 2014 EURIBOR futures. Read data like this: a 100 minus the price equals the interest rate.
Figure 1. EURIBOR futures: June 2014.
Note: EURIBOR is interest on a euro interbank deposit having approximately €1 million principal value for a term of three months, for spot settlement on 3rd Wednesday of contract Delivery Month (source: CMEGroup.com)
So what's next for the markets?
We feel it's going to continue to be all about Europe. So without trying to forecast the future, we will monitor the EURIBOR futures, specifically the June 2014 contract. Additionally, we will closely monitor the May 2015 contract on Federal Funds futures, which predict that the Fed is boost the interest rates to 50 basis points, a year later than the ECB! Yet, we point that the bullish expectations are primarily embedded in the EURIBOR futures. Any deterioration in EURIBOR futures is bullish for gold (GLD), but also bullish for the U.S. dollar (UUP), and bearish for crude oil (USO), (OIL), and finally bearish for stocks - back to the risk-on trade.