As the ECB gears up for its next meeting in two weeks, we heard from two key members today Vitor Constancio who is the ECB VP and Peter Praet, the chief economist and neither is in any rush to unplug the printing machines. Vitor said “I think that when we look to the history of monetary policy both in Europe and outside, we have to be cautious about premature withdrawal of stimulus.” I can understand if he is talking about when the ECB raised rates by 25 bps in 2008 two months before Lehman went under but if he looked at the Greenspan experience in the mid 2000’s the main criticism was that he left rates too low for too long. Peter Praet is acknowledging the “increasingly solid cyclical recovery” in Europe and believes the “risks of deflation have vanished” but at the same time “underlying inflation is still subdued.” But, while “subdued” he also said “with the closing of the output gap in the medium term there will be pressure on prices and our objective will be fulfilled.” As to when he forecasts that gap to close, “sometime in 2019. We don’t want to be more precise.” Thus, neither told us much about what they’ll say in two weeks but it doesn’t sound like anything substantive.
Mario Draghi speaks this morning too and I’m sure he’ll echo the same dovish flare which means that June won’t likely give us much more information on when the next taper will begin (most likely September). That said, they will very likely back off from continuously saying that rates could still go lower and QE can be ramped up again. While that’s very possible at some point again, it sounds ridiculous right now. I mean the ECB has policy currently fit for treating a complete economic disaster all because they wants 2% inflation. The politics in the region have dramatically calmed and growth is certainly much better proving that higher inflation is not a precursor to better real growth. In fact it detracts from it as it squeezes everyone in some form.
In the name of 2% inflation we all know the bond mania the ECB has created in Europe. So what does the ECB’s Financial Stability Review out today say about the current market environment: “Overall, risks to financial stability stemming from financial markets remain significant, mainly owing to the possibility of a further rapid repricing in global fixed income markets.” The underline is mine and you can’t make this stuff up. WTF do they think will happen to at least the European fixed income market as the ECB further tapers and eventually gets rid of negative interest rates that would vaporize at least trillions of dollars of wealth for those that hold those negative yielding bonds? Sorry for the rant but AGAIN, the removal of monetary accommodation globally should be your number one focus for markets this year and next. Not what DJT says and not what tax reform looks like, although both of course are hugely important.
The euro is little changed, bonds are modestly higher and stocks are modestly lower in Europe in response to the ECB commentary.
Bullish sentiment cooled down this past week according to II. Bulls fell by 6.2 pts to 51.9% which is the lowest in 5 weeks but again, most went only to the Correction side which still is made up with bulls. Bears were higher by 1.2 pts to just 18.3. When the Bull side reached its 30 yr high on March 1st the S&P 500 stood at 2396. It closed yesterday at 2398. The DJIA was 21,116 on March 1st and was 20,938 yesterday. The Russell 2000 is 33 pts below that March 1st close while the NASDAQ is higher by 4% because of you know who but the cumulative advance/decline line in the NASDAQ is exactly where it was on March 1st. Point being is that when exuberance gets extreme as it did on March 1st, it’s time for a cooling down period.
After seeing a weaker than expected new home sale figure yesterday, mortgage applications to buy a home fell for the 2nd week in the past 3 in May. It was lower by .7% and are now up 3.5% y/o/y. For the month to date, applications are down 1.8% vs the last print in April. This is even as the average 30 yr mortgage rate fell to the lowest level since November and that instead only helped refi’s which jumped by 10.5% while still down 30% y/o/y. We see existing home sales today but that’s somewhat dated date because it only measures closings.
The other story of the day was Moody’s one notch downgrade of China to A1 on the “expectation that China’s financial strength will erode somewhat over the coming years, with economy wide debt continuing to rise as potential growth slows.” They seem optimistic on the reforms “to transform the economy and financial system over time” but “it is not likely to prevent a further material rise in economy wide debt, and the consequent increase in contingent liabilities for the government.” Total Chinese debt consisting of government, household and non financial corporates sits at 256% of GDP which Moody’s expects will continue to rise. They said this level is not uncommon in highly rated countries but “they tend to be seen in countries which have much higher per capita incomes, deeper financial markets and stronger institutions than China’s.” Bottom line, there is nothing new here that we don’t already know. The Shanghai comp as well as the H share index were both unchanged overnight. Credit markets were uneventful and the yuan is mixed.