The main event of the day, of course, was the ECB meeting and, despite the weakening of its two pillars of monetary policy (inflation and money supply), it chose to neither change policy nor its overall assessment. This does not mean that the meeting and Draghi's press conference were non-events or contained no new information.
With many expecting action by the ECB, and apparently more thinking it was a 50/50 call, the disappointment saw the euro rise to new highs for the week above $1.36 after testing the year's low near $1.3480.
The next hurdle for a more sustained euro recovery is seen near $1.3640 and may come into play tomorrow on the volatility that will likely be injected by the US employment report; noisy by the weather and the loss of emergency jobless benefits and benchmark revisions. A break of $1.3550 would cast doubt on this more favorable outlook, while it may take a move back above $1.3700 to convince the bears they got it wrong (again).
Perhaps the most frustrating for market participants was Draghi's insistence that there is no deflation in the EMU. Two points ought to be made. First, Draghi is talking about the euro area as a whole. It is on this level that monetary policy needs to be conducted. We have argued the deflation in a few countries, and the disinflation in others, is part of the internal adjustment process.
Second, the facts may change, and Draghi has not ruled out additional action. Although the November rate cut came before the staff economic update and forecasts, this time he referred to them, seemingly raising their level of importance. The January inflation report to be released a few days before the next ECB meeting will be critical. A further decline in inflation is likely. Speculation of a March move is likely to intensify as the meeting draws near.
Still, the general sense one is left with is that the ECB is in no hurry. As Noyer, the Governor of the French central bank put it, while the situation is not normal, but not alarming either. Draghi played down the decline in the lending contraction by noting that 1) it was stabilizing and 2) that new corporate bond issues have largely made up for the decline in bank loans. While Draghi once again seemed most sympathetic to efforts to revive the ABS market, this does not seem likely to yield near-term results.
Ironically, the ECB's reluctance to provide more financial assistance has coincided with what could possibly prove to be an end to the trend in the global capital market: weaker equities, emerging market swoon and a rally in US Treasuries, which lifted core bonds.
Asset managers had appeared to generally raise cash levels, awaiting a correction for better entry levels. The question we have repeatedly heard recently was whether the correction has been sufficient. Sentiment was clearly biased toward increasing exposure. We suspect that barring a major negative surprise in the US jobs data, when extraneous factors are taken into account, the trend of the past six weeks will at least correct.
Regardless of the noise/signal risk in the jobs report, the FOMC will see another one before their next meeting. The new Federal Reserve Chair, Yellen will testify before Congress next week. It is unlikely that she will deviate from the official position as articulated in the recent FOMC statement. The Fed's tapering program remains intact and the bar to change seems relatively high. What it means to be dovish and hawkish changes with circumstances. The doves are not arguing to roll back the tapering. They are arguing for maintaining the current pace. The hawks, which given the new configuration of the FOMC are somewhat more represented among the regional presidents, pressing for an acceleration tapering.
Central bankers and economists have long argued that unemployment is a lagging indicator. Yet, both in the US and UK the forward guidance was clearly linked to the unemployment rate. The Bank of England's quarterly inflation report, due next week, has been signaled by Carney as the venue in which its forward guidance will be updated. Unemployment is a poor measure of the labor market. Central bankers should give emphasis to unit labor costs. Yet, given the central banker's bias in the distribution of productivity gains toward profits, perhaps forward guidance should be linked to wage growth rather than unemployment.