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ECB Minutes Analysis, October 6, 2017

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There were no real surprises in the minutes of the September ECB meeting, but nonetheless the minutes caused a modestly decline in the euro, which fell 0.4% following their release.

The reason for the decline was the discussion of euro strength, and the risk it poses to the EU economy. Remember, one of the reasons the euro accelerated so much in August was because ECB President Draghi refused to take multiple opportunities to comment on euro strength, and the market took those omissions as tacit endorsements of the stronger euro.

But, yesterday’s minutes told us the ECB has indeed noticed the 12% rise in the euro vs. the dollar, and if the euro stays strong it may impact its upcoming tapering decision, due on Oct. 26.

To be clear, the stronger euro won’t delay that tapering decision, but it could make the reduction in QE more gradual. And that matters, because with the euro at 1.17 vs. the dollar, a very gradual tapering is not priced in, and that represents downside risk in the euro—perhaps into the low 1.10- 1.15 range depending on taper details.

That also matters for US stocks, because if the euro falls, the dollar will rise, and a stronger dollar will, at some point, become a headwind on stocks if we don’t see continued acceleration in inflation or economic data.

Bottom line, the ECB meeting is a real risk to our “Virtuous Reflation,” because if they are dovish and cause a dollar rally, that may indeed hit stocks. That’s not necessarily a problem until later in the month, but I do want everyone to be aware of it.

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Weekly Market Preview, October 2, 2017

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Last Week in Review

Economic data was mixed last week from a reflation standpoint, as growth data was a positive surprise while inflation data mildly disappointed. But, importantly, the inflation numbers weren’t enough to cause a reversal of the reflation trade or cause an unwind of the gains.

Inflation data remains the most important data point in the market, and Friday’s Core PCE Price Index was a mild disappointment. The August reading rose 0.1% vs. (E) 0.2%, while year-over-year Core PCE Price Index rose 1.2% vs. (E) 1.3%. That’s still well below the Fed’s 2.0% target, and it does somewhat undermine the strong CPI report—but it’s not the kind of number that would make the Fed think inflation is getting materially worse, and as such it didn’t cause a big move in markets.

Staying with inflation, the data was similarly underwhelming with the flash core EU HICP. It rose just 1.1% vs. (E) 1.2%, again sapping some of the positive momentum from the firm CPI data from earlier in December (Chinese, British, US). But like the soft Core PCE Price Index, it wasn’t a major market mover and it doesn’t undermine the fact that there are “green shoots” of inflation lurking out there, so it didn’t cause a pullback.

Looking at growth data, it was more positive. Durable Goods was the other important report from last week, and it handily beat estimates. New Orders for Non-Defense Capital Good ex-Aircraft rose 0.9% vs. (E) 0.3%, and the July number was revised higher to 1.1% from 0.4%. That number is important, because it implies that we’re seeing an acceleration of business spending and investment—and if that continues it will help create that economic “rising tide” that we need to help push stocks materially higher.

This Week’s Preview

For the remainder of the year, every week is an important one for markets as there will need to be constant reinforcement of virtuous reflation, but this week is more important than most given we get the global ISM PMIs and the US jobs report.

Starting with the latter, it’s jobs week, so we get ADP Wednesday, Claims Thursday, and the government report on Friday. We’ll do our normal Goldilocks preview later this week, but once again the wage number will be the key component of this release, and once again the risks are for a number being “Too Hot” and potentially recalibrating Fed rate hike expectations.

Beyond the jobs report, we get the global manufacturing PMIs (out later this morning for the US) and global composite PMIs (out Wednesday). Given the growing number of global central banks that are already removing accommodation (Fed, Bank of Canada) or are about to remove accommodation (ECB, Bank of England) economic growth data needs to stay firm to avoid a “stagflation” scare. So, Goldilocks numbers from both the manufacturing and composite PMIs this week will be welcomed by stocks.

Finally, turning to central banks, the minutes from the September ECB meeting will be released on Thursday, and investors will be searching for clues as to the severity and pace of the Fed’s taper. The
ECB usually plays things pretty close to the vest, so it’s unlikely we’ll see too much revealed in the minutes (they are going to do that at the October meeting), but the bottom line is any hints of extra hawkishness from the minutes could be a mild headwind on stocks this week. Bottom line, economic data in September helped spur a virtuous reflation rally, and that will need to continue this week if we’re going to see new highs in stocks.

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