Theme for the Week Ahead: Digestion

After the ECB meeting, and the new initiatives it announced, coupled with the monthly cycle of PMI reports, and the US jobs data last week, investors will have time to digest the developments this week. The economic calendar is light, and the data is unlikely to impact policy expectations.

The impact of the ECB's rate cuts and the formal end to the attempts to sterilize the bonds purchased under the SMP scheme may be seen in the coming days. Will the extra liquidity in the Eurosystem, the negative deposit rate and 15 bp refi rate, succeed in pushing EONIA back below the effective Fed funds rate? Will the cut in the marginal lending rate (the ceiling of the policy corridor) to 40 bp, limit the quarter-end pressures?

The way bank are going to respond to the negative deposit rate will also be closely scrutinized. In Sweden, the negative deposit rate was not really enforced, and in Denmark's experience, the negative rate was not passed through to depositors. The ECB's statement indicated that a negative rate would be applied to a broad range of accounts that the ECB maintains, including some government accounts.

We remain concerned about the potential unintended and undesirable consequences. On one hand, ECB and international officials want European banks to boost their capital cushion. On the other hand, the negative deposit rate seems to act like a tax that capital cushion, or at least the most liquid part of it.

Yet the ECB's actions helped trigger a bond market rally, and this is beneficial to banks many of whom have expanded sovereign bond exposures. The targeted LTRO (TLTRO) facility, to the extent that is drawn up also encourages new carry trades within the euro zone (and may favor risk assets more broadly). Ironically, some European and IMF officials, as well as a few large global asset managers, have expressed concern about the sustainability of the peripheral bond market rally.

The rally in European stocks and bonds should not be confused with a robust economic recovery. The contraction has paved way for what can only be fairly consider stagnation. Just like Paul Kennedy's "Rise and Fall of Great Powers" (1987) seems to have been more applicable to the Soviet Union than the US, the "secular stagnation" hypothesis in its current iteration, seems more applicable to the euro zone.

This will be illustrated by the April industrial production figures this week. On Thursday (June 12), the consensus expects the industrial output expanded by 0.5% after a 0.3% decline in March. The risk is to the downside, especially after Germany's disappointing figures before the weekend (0.2% rather than 0.4%). Consider that the average monthly change was -0.1%, during what appears to be an economic recovery phase. Over the last 12 and 24 months, the average change has been zilch.

The UK also reports industrial output figures (June 10). Over the past 3, 12 and 24 months, UK industrial production has risen 0.2% on average. It is expected to have risen by 0.4% in April, after a 0.1% decline in March.

However, the employment data the following day is more important. The claimant count is expected to have fallen another 20-25k, and the unemployment rate is likely to have ticked down to 6.7%. The data will feed the ongoing debate about the extent of the economic slack. This in turn may see the gradual emergence of a more hawkish wing at the BOE, which could lead to dissents at the MPC later this year.

This is an important week for Chinese data. May trade figures were released over the weekend. The trade surplus nearly doubled to $35.9 bln from $18.5 bln in April. The surprise lied less with exports, which at 7.0% year-over-year increase was only a little more than the 6.7% expected, and more with imports which fell 1.6%. The consensus expected a 6.0% increase. The crackdown on commodity financing may have played a role.

The increase in exports lends support to our view that the Chinese economy is stabilizing. We expect this to be confirmed in this week's reports on retail sales and industrial output. Both PPI and CPI measures of inflation will also be reported. Producer prices have been falling on a year-over-year basis since early 2012. The pace of that decline has been moderating. The -1.5% pace expected in May would be the slowest of the year. Consumer prices are expected to have accelerated to 2.4% from 1.8%.

The retail sales report on June 12 is the economic highlight from the US. A strong rebound is expected after a disappointing April. The consensus calls for a 0.6% increase in the headline figures after a 0.1% increase in April. Strong auto and chain store sales and news of a sharp jump in revolving credit (credit cards) in April warn of risk of an upside surprise.

The Reserve Bank of New Zealand will most likely hike its cash rate by 25 bp to 3.25% at midweek.    The New Zealand dollar has trended lower since early May and bounced in the second half of last week.  The market may have been too aggressive in pricing RBNZ hikes and the market has slowly cut its chances of a follow up hike in July.  A convincing move back above $.08550 may signal the end to the downside correction.  

US bonds are at important levels. If the 10-year yield rises above 2.65%, more participants may become convinced that the yields have bottomed. Among other considerations, the supply increases sharply after falling in the first five months of the year. This may leave the yen vulnerable, even if Japan reports its third consecutive current account surplus (April). We note that such a result would end at least a nine year streak in which the current account balance deteriorated in April from March.