Last week we had the biggest weekly stock market increase in years, up 7 percent for the week! Good holiday sales helped but the big driver was a coordinated effort by six of the world’s largest central banks. The action by these central banks, which was led by the U.S. Federal Reserve, does not directly address Europe’s debt or budget problems. Instead it seeks to minimize the impact of any defaults. In other words, if Greece (or another European country) defaults on their debt there would be direct losses to the bondholders, however the much bigger issue is that the European banking system could seize up due to losses of collateral and capital surpluses. This fear was starting to create a run on some major European banks. The move by the six (non-European) central banks makes it easier and cheaper for those European banks to access short term loans more cheaply and easily. Since the announcement, outflows have been significantly reduced and borrowing costs for European countries have stabilized.
On a related topic, Italy passed a meaningful combination of tax increases and budget cuts this weekend. The European Central bank also signaled that it is willing to take on a larger role than its original mandate in order to stabilize the Euro. The European financial crisis is a long way from over, but now the worst case scenario seems unlikely.