ECB and Fed policies gain traction

Today, the Chinese celebrate the start of a new lunar year, the Year of the Dragon. The ancient Chinese calendar associates this year with water, so this year is also called the Year of the Water Dragon.

Investors, though, may be more inclined to celebrate another kind of liquidity: that provided by central banks.

In December last year, the European Central Bank introduced three-year loans to banks with loosened collateral rules under the Long Term Refinancing Operation to boost liquidity in the euro area. This appears to have succeeded in lowering borrowing costs in the euro area.

Last week saw significant amounts of money raised in Europe, with the European Financial Stability Facility and the governments of France, Spain and several other countries selling debt at mostly lower yields than previous auctions.

Since lower sovereign bond yields also lower the probability of governments defaulting on their debt or being forced into harsher austerity programmes, last week's development, if sustained, will help to stave off a more pronounced downturn in the eurozone economy.

Equities have also benefitted from the improved liquidity and investor sentiment. The STOXX Europe 600 Index rose 2.7 percent to 255.85 last week, its fifth consecutive weekly gain. The index has risen 4.6 percent since the start of 2012, its best start to a year since 1997.

The liquidity injections of the ECB reinforce those from the Federal Reserve in the United States, which has been even more active in helping prop up bond markets over the last few years by directly buying up government securities as part of what many analysts call quantitative easing.

In the case of the US economy, despite doubts raised by many analysts over the efficacy of the Fed's securities purchase programmes, especially the one started in late 2010, economic data released last week indicate that the Fed's ultra-easy monetary policy may be gaining traction.

With the Fed now buying longer-term government securities, together with many foreign central banks who have been doing it for many years, the yield curve has lost much of its historical reliability as an indicator of monetary conditions.

The housing industry, however, has always been sensitive to monetary conditions and last week's mostly positive housing data suggest that monetary policy is helping the US economy to recover.

Housing starts, a leading indicator of the economy, hit an annual rate of 657,000 in December. Although this was down 4.1 percent from November, this rate of starts has, apart from November, been exceeded only once since the end of the last recession.

Indeed, housing starts in the fourth quarter was the highest since the fourth quarter of 2008 in the middle of the last recession.

In addition, the National Association of Home Builders/Wells Fargo housing market index, which usually correlates well with housing starts, jumped from 21 in December to 25 in January. This is the highest level in the index since June 2007 before the last recession.

Finally, existing home sales rose 5.0 percent in December, hitting an 11-month high.

So thanks to the ECB and the Fed, there is hope that the Year of the Water Dragon may not turn out as bad as some economists had feared.