Waiting for Draghi

The US dollar recouped some of the modest losses seen in North America yesterday.  The focus is not, though, so much on the US today.  The Bank of England, and even more important for the markets today, the ECB meets.  Draghi's press conference is the highlight of the remainder of today's 24-hour session.  

Most observers continue to expect the UK economy lead the G7 this year in growth, and that the BOE will be the first of the major central banks to lift rates.  However, as that move most certainly won't happen today, the BOE meeting will not have any impact. 

The most recent data suggest consumer inflation has not bottomed, but that growth is stabilizing, having seemingly reached a speed limit.  For forward guidance, next week inflation report (August 13) is more important in the current environment than the MPC meetings.   The minutes for today's meeting will be released a week later (August 20).  Some observers suggest a hawkish dissent is likely.  

The ECB meeting is important even though there is unlikely to be new policy initiatives launched.  Many have expressed interest in Draghi's geo-political comments, but in these matters we should not expect much more than the obvious:  It is a cause of concern.  It adds to the downside risks.  His assessment of the economy is considerably more important.  

There are three issues here:  the real economy, credit conditions and prices.  The real economy is disappointing.  This underscored by the soft German industrial production figures today (0.3% vs 1.2% consensus) and the unexpectedly dismal factory order data yesterday (-3.2% vs 0.9% consensus), and contraction in the Italian Q2 GDP (-0.1%).  Talking about the return of recession in Italy is may be misleading.  From an investor and policy vantage point, it may be better to conceive of the situation as one continues recession, rather than a double or triple dip.  The Italian economy (and the French economy?) have simply not returned to a sustainable growth path. 

Draghi can find a glimmer of hope in the recent credit conditions.  Both the supply and demand have shown initial improvement.  This could be seen as encouraging, though a disconnect from the real economy could be worrisome. 

The ECB staff projects inflation this year will be 0.7%.  This requires it to be bottoming out, but it appears to have made a new low in June.  The risks are still on the downside.  

The bottom line, though, is next month is more important for the ECB than today's meeting.  In September, the staff will update its forecasts.  The risks are that both growth and inflation forecasts are shaved.  Next month, the ECB's new TLTRO will be launched.  

One way in which these economic, financial and geopolitical forces are being played out is that German 10-year yields have set new record lows, edging closer to the 1.0% threshold.  Today, for the first time since May 2013, the German 2-year yield dipped below zero. 

 The Australian dollar has lost the better part of 1% today in response to disappointing employment data.  It has fallen to about $0.9260 after reaching a six-day high yesterday near $0.9375.  We have been somewhat for bearish the Aussie on ideas that many in the markets are under-estimating the risk of another rate cut.  We continue to look for a test on the lower end of the four-month range near $0.9200 (the 200-day moving average is now $0.9180).  

After the jump in the unemployment rate to 6.4% from 6.0% (first time above the US rate since before the crisis) and the loss of 300 jobs instead of increasing 13.2k as the consensus expected, the risk of a rate cut according the OIS curve rose to about 1 in 5 from 1in 8.    That said, there are two mitigating factors.  First, the RBA has recognized that it will take the labor market a while to adjust to the economic restructuring taking place.  Second, the softness in the job creation is over-stated.  The fact of the matter is that 14.5k net new full-time jobs were created.  This is well above long-term averages.

The BOJ's two-day meeting concludes tomorrow.  Recent data may have raised concerns about demand, and therefore, production.   Foreign demand via exports continue to disappoint,  and household demand remains poor following the retail sales tax increase.  It is still too early to expect the BOJ to respond with new initiatives.  However, if the economy does falter into Q3, some monetary response cannot be ruled out, but we also see risk of a supplemental budget.  

The dollar has fully recovered from that wind pocket which some blame on an error coming from the futures market.  Given that the US 10-year yield is just below 2.46%, the dollar remains firmer against the yen than we would have expected.  There has been talk of good Japanese corporate demand for dollars.    Separately, we note that Japanese shares rallied into the close amid reports that the government pension fund (GPIF) is boosting its equity holdings to 20% from 12%.  Such speculation has been a steady current since the start of the year.