Digestion is Main Focus

US employment data is usually the main highlight on the first Friday of a new month.  However, we argue that this month could be different.   The strength of the US economy now taken for granted, with Q3 GDP expanding at something north of 3%.   The US economy is moving toward the Fed's mandates, and this is expected to be reflected in the FOMC statement at the conclusion of the September 16-17 meeting. 

Perhaps today's jobs data will be important in one context.  Consider that the older ISM reports showed an improvement in employment readings, while the newer Markit PMIs did not.  A softer than expected employment report may encourage participants to begin giving more credence to the Markit survey for the US.   

There were two economic reports from Europe that are noteworthy.  First, Swedish data was simply dreadful.  Industrial output in July was expected to have risen by 2.3%.  Instead, it fell 1.1%.  This follows on the heels of other disappointing data that included GDP, retail sale and PMI.  The Riksbank tweaked its repo path this week, but still suggested a hike by the end of next year was most likely.  Moreover, the June report was revised lower (0.8% from 1.0%), and the forward looking order data shows continued weakness.  It fell 1% in July, which is the third decline in four months.   Sweden's national election will be held on September 14, and the polls suggest a coalition led by opposition Social Democrats will lead the next government.  It is more inclined to provide additional stimulus.   

Second, following the stronger than expected industrial orders data out yesterday (4.6% month-over-month vs expectations for 1.5%), Germany reported a healthy rise in industrial production today.  The 1.9% increase contrasts with the 0.4% consensus forecast and the tending lower manufacturing PMI.  It is the largest monthly increase since March 2012.  It should help ease fears that the contraction in Q2 will be repeated in Q3.  

The major foreign currencies are consolidating, mostly within yesterday's ranges.  Both sterling and the yen broke down further earlier but have returned to yesterday's ranges.  This matches what we detect is the most of the market, and that is digesting yesterday's developments.  

Our key view was that the TLTRO was the main focus of ECB officials.  We linked our minority call for a rate cut to helping ensure a more successful operation.  We did not think an ABS purchase program would be announced before the TLTRO was launched.  In some ways, this is what happened.  Draghi did not provide much specifics including size of the ABS/covered bond purchase plan.  He did provide color.  For example, mortgage-backed securities would be included.  It is possible that the "modalities" of the purchases will be decided only after the participation of the TLTRO is understood. 

It seems much of the discussions centers around definitions.  Does this qualify as quantitative easing?  At the heart of the issue is the fact that there is no agreed upon definition.  In this regard, it is like the word "recession" and "depression".  The Federal Reserve, for example, did not call its asset purchases QE.  Bernanke said it was credit easing.  It was called "LSAP."   The Fed bought Treasuries and MBS.  The BOJ called its program qualitative and quantitative easing (QQE).  It buys commercial paper, corporate bonds, ETFs, REITS, as well as Japanese government bonds. 

Draghi's announcement indicated that there would be outright purchases and a shift in the composition of the ECB's balance sheet.  Therefore, there seems to be little reasons to deny that it is QE.  Indeed, isn't that why the decision was not unanimous?  Draghi indicated that it was decided by a "comfortable majority."  The Wall Street Journal reports that the Bundesbank's Weidmann was opposed, which is hardly surprising, though we suspect that it was not alone, and perhaps the Dutch voted against it as well.   

The fact that Germany was in opposition is important.  Recall German ECB members also opposed Trichet's SMP purchases.  The take away is that while Germany may be the first among equals, it does not dictate ECB policy.  Moreover, we think it is important that the ECB operationally will change next year--fewer policy meetings and voting on a rotating basis, which means that the Bundesbank will not even vote at every meeting.  Our speculation that Weidmann will be the next ECB President was only reinforced by yesterday's developments, even if the scenario of an early departure from Draghi (middle of next year ostensible to become the next President of Italy) that we suggested is too far off to be taken too seriously.  Some has suggested to us that this would be a step down for Draghi, but helping modernize and rebuild the Italian economy may do more good for the euro area than he can do going forward with the ECB, now that the repo rate is near zero and European-style QE will be launched. 

While the euro is consolidating yesterday's steep losses, peripheral bond yields are still extending their decline to new record lows, and the premium over Germany continues to narrow.   The German and Duch yield curve is negative through three years.  The French curve is negative through two years, while the three-year bond yields less than 1 bp.  

The divergence between the US and eurozone will continue to drive the euro lower on a trend basis.  The short-term speculative market is quite extended, and modest bounces are still likely to be sold.  We peg initial resistance near $1.2980 and then $1.3020.  On the downside, the next main target is a retracement level of the euro's advance since Draghi's famous commitment in July 2012 (which the Bundesbank, among others, argued against before the German Constitutional Court), which is found just below $1.2800.