- U.S. import prices expected to remain weak
- ECB pulls out a bazooka but markets are not overly impressed
U.S. import prices expected to remain weak — The market is expecting today’s Feb U.S. import price index to remain very weak with a decline of -0.7% m/m and -6.5% y/y. That would follow the Jan report of -1.1% m/m and -6.2% y/y. U.S. import prices continue to be very weak due to the sharp drop in commodity prices and the effects of the strong dollar. U.S. import prices are showing weakness across the board as seen by the fact that import prices ex-petroleum in January fell by -3.1% y/y, just above Dec’s 6-1/2 year low of -3.6%.
The decline in import prices continues to keep downward pressure on the overall U.S. inflation statistics. However, the Fed expects the import prices to level out as commodity prices stabilize and as the effects of the strong dollar roll off, which would put some upward pressure on the overall U.S. inflation measures. In fact, there is already some concern about higher inflation caused by the recent rise in the inflation statistics. The core PCE deflator in January, for example, popped up to a 3-1/4 year high of +1.7% y/y from the 5-year low of +1.3% seen during most of 2015. The core PCE deflator is still below the Fed’s +2.0% inflation target, but the recent rise in the inflation rate suggests that some inflation pressures may be bubbling below the surface. Meanwhile, the core CPI in January rose to a 3-3/4 year high of +2.2% y/y and was up by +2.5% on a 3-month annualized basis.
ECB pulls out a bazooka but markets are not overly impressed — The ECB at its meeting yesterday announced a much more intensive array of easing measures than the market expected. EUR/USD initially fell sharply on the announcement but then rallied back up when ECB President Draghi said that the ECB at present does not anticipate cutting rates further.
The markets had been expecting the ECB to cut its deposit rate by 10 bp and a possible expansion in the QE program. The ECB’s actual move was much broader. The ECB did, in fact, cut its deposit rate by -10 bp to -0.40% but it also cut its refinancing rate by 5 bp to zero. The ECB also surprised the markets by expanding its QE program to 80 billion euros per month from 60 billion euros per month and expanding its securities purchase list to include high-grade corporate bonds. Separately, the ECB did not announce a tiered deposit program to soften the amount of deposits subject to the negative deposit rate.
The ECB also announced an extension of its targeted longer-term refinancing operations (TLTROs) and said that starting in June it would effectively pay banks up to 40 bp (i.e., up to the deposit rate of -0.40%) to take money if the banks are successful in raising their loan amounts. The ECB through its TLTRO program is therefore essentially willing to pay banks to push money out to the public to try to boost economic growth.
The ECB also cut its macroeconomic forecasts. The ECB cut its GDP forecasts for 2016 to +1.4% from +1.7% and for 2017 to +1.7% from +1.9%. The ECB slashed its inflation forecast for 2016 to +0.1% from +1.0% and for 2017 to +1.3% from +1.6%.
The Euro Stoxx 600 Banks stock index yesterday initially rallied sharply to a 2-month high but then fell back and closed the day down -0.52%. The markets remain worried that negative interest rates will undercut already-low European bank margins and put those banks under even more strain. The iShares MSCI European Financials ETF (EUFN) rallied early on the ECB’s announcement, lost some ground, but still ended the day up +0.90%.
The ECB on Thursday essentially threw a lot more stimulus at the wall to see what will stick. The markets initially were not particularly impressed. However, if the ECB’s stimulus moves start to have an effect on stimulating loans and economic activity, without weakening bank profit margins, then the markets may become more friendly to the ECB’s move.
The ECB’s move was clearly medium-term bearish for EUR/USD even if EUR/USD initially saw a bump up on Mr. Draghi’s statement that at this point he doesn’t see further rate cuts. The ECB’s policy at present is enormously more dovish than the Fed’s policy and EUR/USD in the end will suffer. The ECB has negative rates and an expanded QE program and the ECB says it expects interest rates to be at or below current levels for a “long period of time and well past the horizon of our net asset purchases.” The Fed, by contrast, has ended its QE programs, has already raised its federal funds target by 25 bp, and is likely to raise its funds rate target by another notch by late this year or certainly by early next year.
