Cold Water

The question for traders today
Is what will the ECB say
The pace of growth’s slowing
Which just might be throwing
Cold water on Draghi’s leeway

The lack of inflation remains
The feature that Draghi disdains
Perhaps he’ll enlighten
Us on when he’ll tighten
And if so let’s hope he explains

Is this the meeting where Signor Draghi explains the ECB’s next steps? As recently as a month ago, the consensus view was yes. However, four consecutive months of data showing that growth in the Eurozone was slowing has forced a rethink on the subject. Now, expectations are for the ECB to describe the gradual normalization of monetary policy at the June meeting, when they update their macroeconomic forecasts and there are a number of analysts who think it may not be until July. In other words, despite the brave face put on by Draghi and his lieutenants lately when asked about slowing growth, the market is looking at the data and concluding that patience is the watchword. And I agree with them. There is no reason for the ECB to rush to judgment given the recent data mix. After all, they have already promised to keep things steady through at least September. If they wait until July before deciding what to do, the market still has plenty of time to adjust its views.

In fairness, the last thing Draghi wants is to upset the current market mix. He must be especially happy at the euro’s behavior, having fallen a further 2% since they last met in early March. Given the evolution of the market’s expectations, it seems the risk of a hawkish surprise is far greater than that of a dovish surprise, with the result being a euro rebound. Remember, trade is a much bigger issue for the Eurozone, representing 44% of the total economy, than it is for the US, where it is just 12%. So a strong euro has a bigger negative impact on Europe than a strong dollar has on the US. In the end, I expect virtually no change in the statement and for Draghi to come across as dovish at the press conference later.

In the meantime, the market has done very little while awaiting the news. The dollar, which has been on a roll for the last week has ebbed slightly, a move that seems more like modest position adjustments ahead of the ECB meeting than anything else. Perhaps the biggest news was that Sweden’s Riskbank adjusted their forward guidance by saying they don’t see tightening until “towards the end of the year,” rather than in the “second half of this year” as had been their previous view. While these may sound similar on the surface, the meaning to the markets was clear and the SEK immediately fell a further 0.4% vs. the euro, although given the euro’s modest rebound vs. the dollar this morning, it is only weaker by 0.2% vs. the dollar. The point is that the ongoing combination of slowing growth and missing inflation is creating an environment in which it is very difficult for central banks to maintain their policy normalization drive. The risk they fear is that the slowdown is more persistent after they start tightening and they are forced to reverse course quickly. We have seen this in the past and it is a huge blow to their credibility when it occurs.

There is one central bank, however, which does not have that problem, the Fed. While the growth story in the US may have stabilized for now (we’ll know more after tomorrow’s GDP report), rather than continuing to accelerate, there is no ambiguity that inflation is accelerating in the US. In fact, on Friday, a little watched statistic, the Employment Cost Index, is getting a lot more press than normal. This is a quarterly measure of wages and had grown at a 2.6% annual pace when last reported in January. Any uptick there would be quickly noted by the market and would likely be seen as a harbinger of even tighter Fed policy. After all, wage growth is what they are waiting for, so if it starts to show up, they will react. And next week we have a very important data week, with Core PCE, the FOMC meeting and payrolls, so there is plenty to look forward to.

But today is really all about the ECB. We do get US data this morning, starting with the weekly Initial Claims data (exp 230K), but then Durable Goods (1.7%, ex-transport 0.5%) and the Goods Trade Balance (-$74.8B), which, by definition, excludes services. Certainly Durable Goods will be closely watched, but given it is released concurrent with the beginning of the ECB press conference, it would need to be a remarkable print in either direction for traders to react. So all told, today is likely to be dominated by the ECB.

A couple of things to keep in mind are that the 10-year yield remains above 3.0%, albeit barely so, but will continue to draw investment, especially given the dollar’s recent rebound. Fears of an ever-weakening dollar seem to have abated for now. Also, earnings season continues and the equity market has been displaying significant volatility and some counterintuitive moves after releases, so that volatility could well spill over at some point. But in the end, today is Mario’s day.

Good luck