While it wasn’t the “buy everything this isn’t nailed down” rally from Monday, the S&P managed to edge out another record close yesterday, posting a modest 0.04% increase but holding below the psychological 1,900 level. Soft retail sales in the US kept a lid on any exuberant investor optimism, with a decline in import and export prices during the month of April shifting investors expectations that Thursday’s CPI reading will likely remain sluggish. Despite the less than enthusiastic retail sales numbers, the rebound in the DXY continued as the EUR slumped further, with the USD-linked index rallying to levels not seen since early April.
After a relatively uneventful overnight session in Asian markets that saw the major equity indices edge slightly lower, European markets got busy with a number of event risks that traders were keenly focused on. Employment statistics for the UK economy were released earlier this morning, with the number of people claiming unemployment benefits over the month of April falling by just over 25k, a modest disappointment given that analysts had expected a similar performance compared to March when we saw a decrease of 30k people. The unemployment rate was also released at the same time and as expected dropped from 6.9% to 6.8% in March, however earnings over a three month period compared to the same time frame slide to only a 1.7% increase versus expectations of a 2.1% rise, highlighting some of the issues with excess slack in the labour market. While the unemployment is now well situated below 7%, the weak returns on labour are likely to help the BoE justify keeping rates on hold for a longer period of time.
Shortly after the employment situation, the BoE’s Quarterly Inflation Report was released, and was a little more on the dovish side than markets had anticipated. The key takeaway from the report was that more slack in the economy can be absorbed before rates begin to rise, and while Carney did acknowledge the British economy is moving closer to the point of needing tighter policy, the BoE is prepared to wait until 2015 before raising rates. In response to the potential for an overheating housing market, Carney opted to state that the first line of defense against a housing bubble was to tweak mortgage lending rather than raising rates, with the ability to amend macro-prudential policy measures so as to keep the affects limited to the housing market itself. The release of the QIR and the lack of urgency to tighten policy had participants re-pricing expectations of the first rate hike from February 2015 to March 2015, and subsequently causing the Sterling to come under selling pressure; GBPUSD fell below the 1.68 level, but is starting to find a base in the high-1.67s.
The speculation as to what the ECB will do at their next policy meeting continues to run rampant, with the central bank economists Mersch and Praet outlining a number of policy measures that could be introduced at the June meeting. There was nothing new in terms of what Mersch and Praet outlined (rate cuts, new LTRO, ABS purchases), yet the markets have keyed in on what was not said, as the economists stopped short of reinforcing the expectation for the introduction of a full scale QE program. Reports released this morning that have cited sources familiar with the matter seem to indicate the ECB has settled on at least cutting rates in June, with members leaning towards also introducing either a targeted LTRO or an ABS purchase program comprised of SME loans. The failure to stoke the fire in regards to a large-scale bond purchase program has helped the EUR find some support against the dollar this morning, with EURUSD garnering a bid ton in the low-1.37s.
Heading into the North American open, S&P futures are looking content to ease back from their record close, with a moderate weight t to the tape that is setting up for a negative start to the day. Commodities on the other hand are broadly higher, with the lack of de-escalation in Ukraine pushing investors to increase exposure to hard assets. A relatively dovish BoE and potential for more accommodation from the ECB has gold well above the $1,300 level, while front-month WTI surpasses $102/barrel, and copper jumps above $316/lb. USDCAD is struggling with the 1.09 pivot again, it’s third consecutive session being pinned to the round number. While commodity prices and demand for commodity-linked currencies are lending support to the Loonie, US-CDN yields spreads continue to rise and thus warn of upside risk in USDCAD.
With a rather quiet day on the docket in terms of economic releases for North America, things pick-up tomorrow with manufacturing sales out of Canada and consumer prices in the US. Considering the Federal Reserve in on a well-defined tapering schedule with little in the way that could derail the wind-up of its asset purchase program by the fall, market participants have now shifted their focus to how consumer price levels will affect the time-line of when the Fed will first start to raise short-term rates. Should inflation remain well contained below the 2% rate, this will allow the Fed a greater amount of breathing room and the flexibility to keep rates low in the hopes of making sure the recovery doesn’t falter, while the prospect of inflation potentially pushing towards the upper end of the Fed’s target will increase speculation the Fed will have to look at raising rates by the middle of 2015.
The median analyst estimate is forecasting that the headline CPI reading for April will reach the mid-point of the Fed’s band at 2.0%, up from the 1.5% that was registered in March. While on the face of things a 2% print suggests a subdued inflationary environment will not be an issue in America, the headline reading is discounted somewhat considering the core reading is expected to remain flat at 1.7%, with some of the higher prices in the more volatile items being transitory in nature. A hotter than expected reading north of the 2.0% mark would generate buying demand for the USD as traders shift their view forward on when the Fed might be looking to raise rates, with a sub-2.0% reading have an opposing effect on the USD as bond demand increases. In terms of what could be expected tomorrow, soft retail sales and a decline in import/export prices were somewhat mitigated by the fact that the PPI index for April increased by more than forecast coming in with a 0.6% increase, however we feel there is a good possibility of a downside surprise with the release as competition in the retail space will likely keep producers from passing along those increased costs to their end users, and thus the potential for the USD to elicit an offer tone from traders.