On the surface, investors seem content that their expectations of more stimuli from the ECB and the BoJ, or in fact any central bank, are again helping to contain their reaction to Italian political and event stress. However, between some of the different asset classes there seems to be disconnect, especially how equities and commodities are being traded. Bourses on either side of the Atlantic are surging, while oil and copper prices are retreating from this year's highs. Commodities are simply reacting to economic data, which is “stagnant at best” – the U.S. sequester appears to be the killjoy of the party – while stocks continue to respond to the "continued" dovishness of Bernanke and company and the current low yield on offer from fixed income-land.
This morning central banks rate decisions are again the main event. Draghi and company at the ECB and outgoing Governor King at the Bank of England get to “strut their stuff.” The market take so far is a tad mixed. So far this week central bank decisions have gone according to plan. The line on the ECB is that a -25bp cut is much more likely in Q2 than this month. However, the inconclusive Italian election result has increased the risk of a dovish ECB surprise. The Fixed Income market has priced in a +30% chance of a refinance-rate cut at this morning’s meeting.
Despite some weaker euro-data points of late the bolder move by "powers that be" at the ECB would be to prudently keeps rates on hold. It’s sensible for policy makers to keep something in reserve, especially in case of escalating political problems actually occurring in Italy. Sign posting a rate cut would probably only temporarily boost confidence and a -25bp rate cut now would actually do very little to the real economy in the short to medium term. By end of day, euro policy makers have to make the peripherals' economies more competitive through reform. The peripheries require growth for the EUR pet project to survive. A further loosening of the collateral framework to support credit to SMEs might also be required.
The Bank of England has an even tougher assignment. Noting the poor run of U.K. economic data certainly increases the chances that the MPC could expand its asset purchase program this morning. It is a very close call. The broad consensus is for the program to remain unchanged at +GBP375m, with a small percentage of investors slightly favoring an additional +£25b of purchases. The minutes from last month’s decision show that three members of the MPC (Fisher, Miles and King) voted for an extension of QE by +£25b. Last week, another member, Paul Tucker, appeared open to the possibility of further asset-purchases. The statement accompanying the decision is expected to highlight the “downside risks to growth.” Perhaps U.K. policy makers prefer to wait for the “new kid” to come and rock the boat?
The Bank of Japan kept its policy unchanged last night, and reiterated its commitment to pursue aggressive monetary easing, very much in line with market expectations. One board member (Miyao) proposed to continue with a virtually “zero” interest rate policy until the Bank judges the achievement of the price stability target to be in sight, while another (Shirai) proposed starting open ended asset-purchases immediately. Both proposals were defeated by a majority vote. The communiqué indicated that Japan’s economy had “stopped weakening” – as opposed to “appear to stop weakening” in its February statement. The upgrade does not however suggest that their economy is on the brink of “inflection point.” In reality, the impact of a weaker yen has yet to appear in the inflation numbers. Outgoing Governor Shirakawa has done little to upset the “apple cart.” Under Abenomics, this market has high expectations for bolder easing moves.
An ever-increasing dovish Bank of Canada is now indicating that investors should expect an accommodative stance from Canadian policy makers “for an appropriate period of time.” Fresh bets are looking at the middle of next year at least for any rate movement now that the BoC held its key overnight rates steady at +1% and toned down its language on further rate hikes yesterday. The penultimate stand pat decision by outgoing governor Carney was largely predicted and bore little surprise. However, some individuals had expected the Central Bank to entirely drop language signaling future rate hikes. In fact, all they did was replace “less imminent” with language suggesting a longer stay on the sidelines.
The rates market continues to give the EUR a helping hand. An overall increase in domestic buying, especially in the front end, is helping the peripherals market extend their gains. The ECB’s OMT program provides assurance as a backstop demand for sovereign bonds and gives investors confidence to want to own some of these debt instruments. All eyes were on this morning’s +EUR4-5b 10/15, 1/18 and 1/23 taps from the Spanish tesoro. It was another good showing with the auction once again overfilled, providing solid cover and lower yields. The somewhat impressive results allowed the single currency to visit its overnight highs. Where to from here?
The current market seems to be distorted towards more pessimistic ECB projections. Investor consensus is broadly for the key rate to remain unchanged, although a small percentage is looking for a cut, an outcome that will push the EUR significantly lower. On the other hand, if the growth and inflation projections are lowered today, coupled with the current pessimistic positioning, pullback will be limiting under this scenario. The EUR will trade under pressure, but with 1.2875 providing good support. On the other hand, if the ECB is much more optimistic, and with the markets current positioning, the resistance at 1.3315 and above looks in danger to be tackled.