Eurozone CPI fell 0.2% in December when the market was expecting a flat reading. Earlier in the week, we had already seen a disappointing reading out of Germany and perhaps this was a sign of things to come.
However, the core reading, which excludes food, energy, alcohol and tobacco actually ticked a bit higher and some found this to be a positive, given it implies things are not as bad as they seem.
With broad expectations that we’ll see action by the ECB, European equities bounced back as deflation fears flared up. Investors even ignored more wild swings in oil prices and focused instead on the FOMC meeting minutes. The minutes reinforced the data-dependency of rates lift-off, with the Fed more confident about growth but concerned about low inflation.
Interestingly, the Fed saw lower oil prices as a net positive for GDP and employment growth, dismissing some of the concerns investors have about lower prices. The Fed also clarified the introduction of the ‘patience’ phase saying it gives it more flexibility to adjust policy.
Overall, it seems the consensus is still for rates lift-off in the middle of this year. The slight risk is for a later-than-middle of the year lift-off due to low inflation and perhaps pressure from a changing global outlook.
Greenback remains resilient
Regardless, the USD managed to gain some ground on the minutes and data, which was ahead of expectations. The ADP non-farm payrolls reading came in at 241,000, well ahead of the 227,000 estimate.
Trade balance data also showed a narrower-than-expected deficit. All signs continue to point towards a firmer greenback. The next key reading will be the official non-farm payrolls on Friday, which is expected at 241,000 with unemployment dropping to 5.7%. Given the seasonality factors impacting December, this would still be a very solid reading. The next few days will bring substantial fedspeak and this will help shape expectations.
Euro weakness persists
Having said that, policy divergence remains a key theme and it is clear EUR/USD is the pair to watch given the sharp contrast in how the two economies are travelling.
Focus this week has been on renewed fears of a Greek exit but comments from Angela Merkel suggesting Greece should stay part of the Eurozone and Germany is open to Greek debt talks certainly helped soothe investor concerns.
We are currently calling the major European bourses firmer at the open with the rebound set to continue for a second day. While sentiment seems to have switched, I remain concerned that it is a headline risk-driven market and it won’t take much to see a reversal in price action.
Traders will continue to watch bond yields very closely and, of course, price action in the euro will be pivotal. Data is limited today but Europe’s retail sales and the UK policy decision deserve some attention.
Japan leads Asia
Looking around the region, the Nikkei is leading the way, with renewed USD/JPY strength breathing some life into Japanese equities. Heading into key US data releases, the recent trend has been bidding the greenback higher against the majors and it seems this will continue to be the case.
The banks are helping the ASX 200 to hold on to some gains, presumably as hopes for ECB action sooner rather than later is encouraging buying in the financials. There are mixed performances in the materials space with big rallies in some of the mid-tier iron ore plays.
Arrium is enjoying double-digit gains after being sold off significantly in past months. Domestic building approvals data showed a 7.5% jump, helping the AUD gain some ground in Asian trade with AUD/USD back above the $0.8100 level. However, the pair is still in a downtrend and some traders will be looking to sell into strength.