ECB Takes Center Stage

The ECB meeting is the session's highlight.  In recognition of the risk that ECB President Draghi expresses displeasure with the premature tightening of financial conditions through the exchange rate channel is encouraged a modest bout of euro selling.  The single currency has drifted back toward the lows seen at the start of the week near $1.1275.  

The euro has held above last week's lows, which were set April 14 near $1.1235.  A retracement target of the euro's gains since March 10 ECB meeting is found near $1.1220.  Although the euro's technical tone has weakened, with the 5-day moving average slipping below the 20-day average this week for the first time since March 10, and the MACDs have crossed to the downside, unless this $1.1220-$1.1235 is convincingly broken, it is difficult to be confident a high is in place.  

The market is vulnerable to "sell the rumor, buy the fact" type of activity.  A euro advance through the $1.1320-$1.1340 area would suggest the euro's pullback has run its course, and a rechallenge of the recent highs is likely.  That said, we recognize that the US premium over Germany has risen by about 10 bp over the past couple of weeks and that this often corresponds to the dollar finding better traction.    

It is unreasonable to expect the ECB to take fresh policy initiatives.  Last month it announced several new measures and all of them have not been implemented.  Details on the corporate bond purchases and, possibly the new TLTROs, are expected.    Given size and liquidity considerations of the corporate bond market and individual issues,  most estimates appear to gravitate around 10-15 bln euros of corporate bond purchases a month.

At last month's meeting, the euro was falling as Draghi announced the new measures but then went on to say that with the 10 bp deposit rate cut and the zero refi rate, that interest rates had reached their floor.  The euro rallied on the news and has not looked back, even though Draghi and other ECB officials have downplayed that assessment.  Draghi is likely to reiterate that it will take whatever action is necessary within its mandate to reach its legally mandated target.  

Draghi may implicitly or explicitly defend the ECB's independence from the encroachment by politicians.  In recent week's some German officials, especially by the finance ministry, have been unusually critical of the ECB.  Even the Bundesbank's Weidmann, who has been critical of the central bank's actions, defended it against the German politicians.  

With negative interest rates, a balanced budget, and infrastructure needs, the EU, the ECB, the US and the IMF have called on Germany to pursue greater fiscal accommodation.  One of the consequences of insufficient aggregate demand at home is that it fuels Germany's large current account surplus, which also violates EU rules as much as other countries' excessive deficits. 

Some German officials argued that the ECB's easy monetary policy spurred the rise of the AfD party. However, AfD campaigned most recently against the German government's immigration stance and had previously focused on apparent costs of assistance to periphery.  Perhaps slow growth and low wage growth despite a tight labor market may have also weighed on voter sentiment.

The discussion of "helicopter money" under which the central bank would finance government spending (or household consumption) directly remains in the realm of theory, but the practicality and perhaps legality remains an open question.  While the ECB will want to keep all of its policy options available, so-called "helicopter money" is not on the table.  Even for those who think that after the summer, the ECB may consider new policy measures, our understanding is "helicopter money" would be a last resort type of response and there are many other measures that would likely be taken first.  

We expect Draghi is offer a robust defense of ECB's actions.  He will point to some positive developments due to the central bank's policy initiatives.   Draghi will suggest that the critics do not have a more compelling strategy to reach the mandated inflation target.  Doing nothing is not an option.  

Sweden's Riksbank meet earlier today.  It kept its repo rate at minus 50 bp and expanded its bond purchase program by SEK45 bln.   Counter-intuitively the krona has strengthened about 0.25% against the US dollar, making it the strongest of the majors so far today.  Two-thirds of the bond purchases will be conventional bonds, and one-third will be inflation linked bonds.  

Sweden's monetary policy stance is more controversial than investors, economists and the media may recognize.   The country enjoys among the strongest growth in Europe and has a large current account surplus.  The lowflation pressures are not causing economic disruption.   The Riksbank seem over-occupied with its currency, though rarely do those that emphasize the currency war meme focus on Sweden.  On trade-weighted basis, the krona has appreciated 3.7% since mid-February and 6% since last August.  However, it is still off 11% from a peak set in March 2013. 

Sterling continues to show a resilience to poor economic news.   This was the case in response to the disappointing employment data.  It is the response today to the unexpectedly weak retail sales data. The median forecast (Bloomberg) was for UK March retail sales to slip 0.1%.  Instead, they tumbled by 1.3%, and the February fall was revised to show a slightly larger decline than initially reported. Excluding auto fuel, retail sales fell 1.6%, the most since January 2014.  The median guesstimate was for a 0.3% decline.  

Separately, the UK reported a GBP4.8 bln deficit in March to finish the fiscal year.  The overall deficit was GBP74 bln or 3.9% of GDP.  This is above the government's target, which means that to achieve its medium-term fiscal objectives, more measures are needed.  

Sterling is largely flat on the day, which means it is holding on to about a cent gain against the dollar this week.  Many of the latest polls suggest a small shift toward the remain camp regarding the referendum.  However, there remains a substantial number of undecided voters, and the outcome appears to be in their hands.   Resistance is seen in the $1.4400-$1.4420 area.  Support is pegged near $1.4250.  

The dollar mad a new marginal high against the yen but continues to hold below JPY110.  A narrow range is prevailing, as the greenback has also held above JPY109.50.   Given that possibility of intervention, which those who believe that major countries are involved in a currency war, have been warning about for at least two months, is remote, the focus returns to monetary policy.  

The BOJ meets next week.  There is heightened speculation that new initiatives will be unveiled that could include more asset purchases, such as ETFs, and possibly deeper negative interest rates.  Recall that the negative deposit rate introduced at the end of January has large exemptions, and some deposits are still paid 10 bp annually, and other deposits have no interest rate (neither positive nor negative).   

The US 10-year premium over Japan has widened by more than 20 bp in the past two weeks.  The premium on two-year money has risen 15 bp.  The widening spread often coincides with a firmer dollar.  The Federal Reserve meets next week as well as the BOJ.  If a June hike is to remain on the table, as three-quarters of economists expect, then next week's FOMC statement should be more upbeat. 

In particular, the global climate, which seemed to have become more salient for the Fed's leadership, has dramatically improved.   Global equities, which had a poor start to the year, have made a spectacular recovery and many indices are at highs for the year.  Commodity prices, including oil and iron ore, have risen.  Emerging markets have recovered  

MSCI Emerging Market equity index has risen by 25% since the January 21 low.  Its 0.5% rise so far today puts it at it highest level since last November.  The Chinese economy shows some preliminary signs of stabilizing.  Rather than fall as so many expected, the yuan has strengthened, albeit slightly, and in any event, the market appears to have become less sensitive to the vagaries of Chinese stocks.  The pick-up in the Chinese property market appears to be having positive knock-on effects for some commodities, such as iron ore and steel. 

The US economic calendar features weekly initial jobless claims and the Philly Fed’s April.  Neither are typically market movers, and this seems especially true today as they will overshadowed by the ECB meeting.  For the record, the Philly Fed reading jumped to 12.4 in March after negative readings since last September.  It may steady this month.  It is best to compare the April reading (estimated around 9.0 with its Q1 average of 2). 

In the bigger picture, it does seem clear that the US economy hit a soft patch in Q4 15 and Q1 16.  However, several drags, like those coming from the manufacturing sector and inventories, appear to be diminishing, which will allow the economy to return toward trend growth (~2%) here in Q2.  

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