Indices gain as traders eye FOMC and Troika Greece decisions

European indices rallied on Tuesday led by gains in the miners, banks and pharmaceutical companies to help Indices gain 0.6% – 1.2%, recovering part of Monday’s falls in the process with investors turning a blind eye to a cut in Italy’s credit rating by Standard & Poor.

Undoubtedly part of today’s gains may have been influenced by short covering from traders who have clear eyes towards the two day FOMC meeting that starts today, along with another call between Greece and the Troika (European Commission, ECB and IMF) where it is hoped both issues will help to support the markets and calm market sentiment.

The fact that talks are ongoing between the Troika and Greece merely emphasises the differences of opinions that are severely threatening the next tranche of loans Greece needs to avoid a default.

One finds it hard to imagine a scenario whereby the Troika will walk away from these talks for a second time, which takes place in another conference call later this afternoon. There is certainly a big risk in that scenario but given the fact that the clock is ticking and that Greece’s spokesman said last night that a deal is close is helping to raise some degrees of optimism that a deal could be struck sooner rather than later.

The move by Standard & Poor to downgrade their credit rating for Italy has been digested relatively well by the market. S+P said that weakening growth, rising borrowing costs and a fragile government would make it hard for the indebted nation to lower their debt burden, all factors which many in the market will find hard to argue with currently.

Today’s reaction to the Italian credit downgrade is most likely one of fortunate timing, as traders have been blindsided by other important decisions to come from the Troika/Greece and the FOMC tomorrow night, which are both likely to have a greater influence of share prices in the near term than the S+P downgrade.

The miners and UK banks have both seen good gains in early trade, but pharmaceutical firms have led, with the FTSE 350 sector gaining over 1.5% as traders buy back into GlaxoSmithKline and Astrazeneca.

FOMC eyed
The start of today’s two day meeting of the FOMC to define the next steps of monetary strategy is a key focus for investors and is likely to play a string role in how equities finish the week.

Speculation of a repeat of ‘Operation Twist’, where the Fed either reinvests maturing bonds into longer term debt or sells their existing short term securities and buys long term securities, has emerged this week by reports in the Wall Street Journal.

Ben Bernanke rarely disappoints the market and tends to be very reactive to developments in the world’s economy. Traders are therefore not completely discounting the potential for an announcement of QE3, but certainly from the murmurs circulating this week this would be unlikely, and an ‘Operation Twist’ type strategy feels more likely at this point, though debate will rage as to whether that policy will fix anything in the long term.

That said, Bernanke and the Fed can ill afford to disappoint investors with Wednesday FOMC decision, which has the potential to send markets tumbling if they fail to provide the support and monetary policy direction investors want to see.