ECB and Beyond

The ECB meeting looms large. The newswire surveys are nearly unanimous. The ECB is not going to take fresh action to address one of a number of issues, including low and falling inflation, anemic money supply growth, contracting lending, and an elevated EONIA.

It is the deflation threat that has been the focus of most market observers. Inflation is considerably less than not just market participants expected, say six months ago, but lower than policy makers anticipated. 

The 0.5% March CPI was a little more than a third of what the ECB had anticipated six months ago. It seems that the good will that Draghi appeared to have earned by his aggressive start (unwinding Trichet’s rate cuts in his first two meetings), and innovation (LTROs), has been dissipated by the shroud over the OMT, which critics argue was a confidence trick (though the trigger to operationalize it was not at the ECB). The seemingly denial of the risk of deflation, with the same fervor that he did when inflation was three times as high stretches credibility. 

Barring a material surprise, simply getting beyond the even risk may see the euro move higher. If Draghi’s (likely) dovishness fails to impress, the short-term market may want to fish for the ECB’s pain threshold. We see initial resistance in the $1.3820-35 area, and a move above $1.3870 would suggest a run toward $1.40 may have begun. 

The service sector PMI for the euro area was a touch softer than the flash reading suggested. It fell from 52.6 in February to 52.2 in March rather than 52.4. There are three observations to share. First, the German PMI (53.0 from 54.0 flash and 55.9 in February) confirms what the manufacturing PMI and other surveys suggest. The German economy may be plateauing. Second, as was the case with the manufacturing, the French economy stabilizing. The 51.5 reading edged out the flash (51.4) and back above 50 (47.2 in February). 

Third, we had noted the past divergence between Germany and France and now the one we note is between Spain and Italy. Italy’s service PMI slipped back below 50 (49.5) whle Spain’s continued to trend higher (54.0 from 53.7). One key take away from this, in the context of the ECB meeting today, is that although the euro area economy is not contracting, growth remains weak, fragile and uneven, in Draghi’s framing of it. However one measures spare capacity, there is plenty of it. 

The UK recovery is considerably stronger than the euro area, but the service sector PMI showed what the construction and manufacturing surveys did. The UK economy has also plateaued. Each of the PMIs this week has been reported below expectations.

However, outside of Europe, the impulses from the US and China are somewhat more positive. Of note, China unveiled an RMB150 bln mini-infrastructure stimulus that will concentrate on railroads in rural areas. Railroad and cement stocks had rallied in anticipation of this, and it seemed a bit like a buy the rumor sell the fact kind of activitiy as the Shanghai Composite fell 0.75% today. 

Separately, the HSBC service PMI for China rose to 51.9 from 51.0, though this was not sufficient offset the 48.0 reading on its manufacturing survey and this kept the composition reading also below 50. The official service PMI slipped to 54.5 from 55.0.

The recent string of US economic data, especially for March, has been suggested a better finish to the quarter after a poor start. US 10-year Treasury yield is near 2.80%, which is the upper end of the where it has been since late January. This has helped lift the dollar to ten week highs against the yen. Some also attribute the backing up of US rates to the shine being taken from some of the high yielding currencies, including the Australian and New Zealand dollars in recent sessions.

There is reason to be a bit skeptical. First, what took the New Zealand dollar down from multi-year highs set on Tuesday was poor domestic news, including plunging milk prices. Second, the Australian dollar’s pullback is modest, encouraged by softer data too. It slipped to a 6-day low today, with bids in front of $0.9200 helping to stabilize it. The service sector PMI equivalent fell to 48.9 from 55.2,and retail sales rose 0.2% in February, slightly softer than expected after a 1.2% rise in January. The trade surplus eased to A$1.2 bln from almost A$1.4 bln in January.   Third, outside of the yen, it seems that short-term US rates are more important for short-term currency direction than long-term rates.

The ECB and its Draghi’s press conference will dominate the North American morning. The February trade balance and weekly initial jobless claims will be lost in the shuffle, but by the time the service ISM is reported, the market’s attention may be somewhat great. Given tomorrow’s jobs report, the employment component of the survey may draw attention.