Inflation in Europe remains
The data that never shows gains
For hawks it’s a worry
As they’re in a hurry
To raise rates ere Europe’s growth wanes
It should be no surprise that inflation remains the topic du jour in markets as it has risen to the top of every central bank’s agenda now that global growth appears in good shape on a synchronized basis. The problem, however, is that despite this uptick in growth, inflation continues to run well below targets. The latest data came from the Eurozone this morning, where headline CPI was released at 1.4%, 0.1% lower than last month but right on expectations, while the core reading, excluding food, energy & tobacco prices, remained stable at 0.9%. The ongoing absence of visible price pressures continues to split the ECB with a slowly growing hawkish wing arguing for a swift end to QE, while the more moderate and dovish members, including Signor Draghi, are perfectly happy to watch from the sidelines. After all, in the doves’ collective mindset, they have already acted by virtue of the reduction in QE purchases to be made starting this month and going forward at least until September. The upshot in the market has been modest weakness in the euro as traders become slightly less certain about the timing of the end of QE. After all, if, come September, Eurozone CPI is still running near current levels with core still around 1.0%, it will be extremely difficult for the ECB to make the case that it is time to end QE. And remember, the key driver in the euro’s ascent over the past nine months has been the idea that the ECB is going to become more aggressive than the Fed in its removal of policy accommodation.
As to the dollar’s overall performance this morning, it has shown broad based, if shallow, strength. In fact, it has rallied against all its G10 brethren, and against most of the emerging market bloc. However, movement overall has been quite limited and I believe that is due to the anticipation of today’s big data release, the payroll report.
Here are updated forecasts:
|Average Hourly Earnings (AHE)||0.3% (2.5% Y/Y)|
|Average Weekly Hours||34.5|
At this stage in a recovery cycle, one has to be impressed by the steady growth in employment. The impact from the hurricanes in September seems to have completely washed through the data, and there is no reason to think this report is going to underperform, especially since yesterday’s ADP number was a blowout on the high side at 250K. The point is that the employment situation in the US remains quite solid. Of more importance in my eyes, and likely in that of the FOMC, is how the AHE number evolves. Remember, the Fed remains ‘all-in’ on their Phillips curve models, and so will see an increase in this number as a critical input into their framework. Finally, keep an eye on the ISM data at 10:00, where further strength will add more pressure to the FOMC to potentially accelerate their policy tightening. Let me say that based on the start to the year in equity markets, there is a strong belief that the data will continue to be quite robust.
Aside from the data, we hear from two more Fed speakers, Philly’s Harker (centrist) and Cleveland’s Mester (hawk) later. Yesterday we heard from St Louis Fed President Bullard (dove) who made an interesting, if unproven point. He said that in countries that have established an explicit inflation target, the private sector has become more confident in central banks’ ability to deliver that target, and thus long-term inflation expectations have gravitated to the target. The impact is that it seems unlikely that inflation will run out of control in those countries. But it has also resulted in extremely sluggish movement in those indicators, meaning that the time line for inflation to regain its target has been extended. Of course, as he is a confirmed dove, he is simply talking his book. He remains keen to come up with a rationale for the Fed to slow down its policy trajectory. However, he is not a voter, and I don’t believe that this theory will gain widespread acceptance any time soon. In fact, I would argue that we have seen inflation run higher, and that the data is simply catching up. My gut tells me that the reaction function in the Fed, as currently constructed, is that strong data today, especially AHE, will lead to thoughts of even faster tightening, while any softness will be overlooked. Too much evidence is pointing to further economic strength, and higher prices by default. I still like the dollar overall on this basis, as I continue to believe the Fed will be more aggressive this year than the market expects.