Much Noise, but Little FX Movement

The US dollar is a little softer against most of the major currencies, but despite the greater news stream, narrow trading ranges persist. The euro has been in about a 30 tick range and sterling a little more than 50 ticks. Tokyo markets were closed, and this may have helped keep the dollar in 20 tick range against the yen.

Perhaps the most important event was Draghi's comments yesterday to the German parliament, where he was quoted Bloomberg indicating that although QE was under consideration it was not imminent and relatively unlikely. This matches our understanding. The ECB's June meeting is a more likely time frame for new initiatives as the staff forecasts will be updated, and officials may have a clearer handle on the trajectory of price pressures.

We can accept that some deflation in the periphery is not totally undesirable. It actually shows that the Berlin Consensus is working. Deflation can be understood as an internal devaluation that will boost competitiveness, and it is more desirable than an external devaluation. We also recognize the fact that economists, including the IMF are not forecasting deflation--outright negative CPI readings--for any EMU member but Greece this year.

The more pressing issue is the rise in EONIA through the repo rate and the continued decline in excess liquidity in the Eurosystem. This, we have suggested, is one of the factors lifting the euro, which., in turn, exposes the downside risks to the economy and prices. This combination of higher overnight rates and strong currency likely meets the Draghi's definition of an "unwarranted" tightening of monetary conditions and could elicit a policy response.

The policy response to this problem is not QE, but lower rates. One measure, that we still do not seem many talking about is a cut in the ECB's lending rate that sits at 75 bp and serves as the upper end of the rate corridor. Most have focused on a cut to the floor of the corridor, which is the zero deposit rate. We remain concerned about the disruptive effect of a negative deposit rate on money market and large depositors, which include government agencies managing their budgets, for example.

Meanwhile, money supply growth remains anemic. M3 grew 1.1% in March. The consensus had expected a small rise after February's 1.3% increase. Lending is also a drag, contracting 2.2%, the same as in February. Lending to households was unchanged, -0.1% year-over-year. When adjusted for loan sales and securitization, lending to households actually increased (0.4%). Weakness continues to be seen in the lending to non-financial businesses, which is off 3% and a little bit more when adjusted for loan sales and securitization.

German states reported April inflation figures, and the national figure will be released early in the North American morning. There is a risk of a slight downside surprise to the consensus expectation of a 1.4% increase after a 1.0% in March (HICP measures is expected to by 1.3% from 0.9% in March). In any event, it is likely to support ideas that inflation in the euro area as a whole ticked up from the 0.8% pace reported in March.

The UK is the first G7 country to report Q1 GDP. The 0.8% quarter-over-quarter pace was a tad below expectations. The short-term speculative market was long, and the slight disappointment was a hand excuse to take profits. Sterling fell about half a cent before finding a good bid below $1.6800. UK yields--both short-sterling and gilts--remain higher on the day. M&A activity is thought to be aiding sterling.

UK growth was concentrated in the service sector, which accounted for almost 90% of Q1 growth. The economy is about 0.6% smaller than at its pre-crisis peak. That means in the current quarter it is likely to reclaim its previous high watermark, joining the US and Germany.

In the North American session, CaseShiller house price index is not usually a market mover. Although yesterday's pending home sales surprised on the upside, the fact of the matter is that the housing market has been a genuine disappointment and the FOMC's statement tomorrow is likely to recognize this. Higher mortgage rates in Q4 last year and the poor weather have taken a toll. CaseShiller house prices appear to have declined for the third consecutive month in February.

The Fed begins its two-day meeting today. This meeting seems to be as close to a non-event as an FOMC meeting may be. There is no press conference following the meeting. It will all be in the statement, and the recent economic performance has not deviated significantly from Fed expectations. The tapering continues, and another $10 bln reduction will bring the monthly purchases in May and the first half of June to $45 bln.