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Having blamed weak growth in the first quarter by passing the blame to the much put-upon cold weather, the Federal Reserve chair expects to see an improvement in the gross domestic product for Q2.
April’s payroll number cut quite a dash, and at first glance appeared to be very impressive; however, it indicated that over 800,000 people disappeared from the workforce, sending the participation rate to a low not seen in 35 years. This has highlighted the need for monetary accommodation to remain in situ, even if it has been wound down gradually since the beginning of 2014.
US bonds showed a fairly muted reaction to the testimony, and markets appear to be satisfied that interest rates will not rise until the latter part of 2015. If anything, the small spike in the ten-treasury yield to 2.6% was more a reaction to the weaker-than-expected US productivity data.
All in all, nothing new was offered by Ms Yellen, other than a distinct reluctance to be tied into a timetable for the initial rate hike. For now, markets are happy to tow the party line and the moves in FX crosses ultimately do little to help the European Central Bank dilemma in the face of an overly strong euro.
Thus, we turn our attentions to the ECB rate decision and the press conference. Mario Draghi has dined out for a couple of years now on his ‘whatever it takes’ speech, and all credit to him; the markets have taken him at his word and we are now witnessing peripheral bond yields at record lows. This renewed faith in the eurozone and indeed the single currency itself, in contributing to the subsequent appreciation in the euro, has vindicated Mr Draghi’s ‘believe me, it will be enough’ rhetoric.
On the other hand, we have been lulled into a false sense of security owing to the success of this speech, and at some point talk becomes cheap. Furthermore, the combination of a weak dollar coupled with the appetite for the euro is indicating just how impotent the ECB is becoming.
Despite all the jawboning, the euro is once again approaching the 2.5 year high reached in mid-March around $1.3970. Many European companies have bemoaned this strength, blaming the declines in first-quarter earnings on the appreciation of the euro.One could imagine that the plethora of short-covering stops and long orders, above the psychological $1.40 level, would suck the euro higher again. Inaction without a clear plan is likely to force the market higher, which coincidentally only adds to the ECB woes.
Perhaps eurozone data remains too inconclusive to warrant action, and Mr Draghi will be conscious of pulling a Trichet and acting too hastily when it comes to policy change. He saw conflicting signals on inflation in April, and the ECB is now considering taking unprecedented steps – as soon as next week – to avert the risk of deflation. The headline annual inflation rate missed forecasts by rising to 0.7% from 0.5% in March. The EONIA has also crept up – this may be viewed as a sign of normalisation but is also a signal of excess reserves drying up.
The fragile recovery in the bloc is also sending mixed signals, but the good macro data tends to neutralise the poor. Economic confidence has declined but consumer sentiment has improved, and unemployment levels appear to be stabilising around 11.9%. The ECB may also wish to wait until June to make any changes so that the inflation expectation report is in hand.
For now, we may have to contend with yet another dovish speech from Mr Draghi, but one wonders whether this time ‘it will be enough’.