In spite of the media coverage, former FBI director, James Comey’s testimony is not the main focus of the bond market, today. That honor goes to Mario Draghi and the ECB and new UST supply, next week.
He still hasn’t found what he’s looking for
It was not surprising that the ECB left monetary policy unchanged. What caught some market participants by surprise was that ECB President Draghi was less hawkish than many market participants and strategists expected, considering the Eurozone’s stronger GDP data. The reason for the somewhat dovish tone by Mr. Draghi? The answer is: Inflation, or more correctly, the lack of it.
The ECB lowered its inflation forecast to 1.6% from 1.7%. The ECB also forecasts Brent crude oil to average $51.6 a barrel in 2017 and $51.4 a barrel in 2018. The ECB forecast the euro to average $1.08 in 2017 and $1.09 from 2018 through 2019. The ECB’s forecast clearly rains on the parades of many strategists. The consensus expectation, heading into 2017, was that the USD would rally close to parity with the EUR, due mainly to almost fairytale expectations that fiscal policies would be swift and significant. The consensus expectation was for the price of crude oil to surge to $60 and beyond. None of these expectations have come to fruition. In my opinion, none will; at least not in the near-term.
Bond bears became excited when the ECB dropped the reference for future rate cuts from its statement, believing it set a hawkish tone. A tone justified by the rebound in EMU GDP. However, at his press conference, President Draghi made it clear that monetary policy would remain extraordinarily accommodative until inflation was moving toward the ECBs 2.0% inflation target. Mr. Draghi stated:
“We have to be confident that the inflation rate is durably converging toward our objective and that it’s a self-sustained convergence. As the recovery strengthens and unemployment fall further, the more confident we become that the convergence is on its way to actually satisfy the conditions.”
Mr. Draghi also stated that lack of core inflation is mostly due to subdued wages,” but he conceded that “wage growth is damped by structural changes.”
As I have said many times: Monetary policy and interest rates, in general, are all about inflation rather than economic growth as measured by GDP. This seems to be a concept that is poorly understood by the current crop of market strategists, portfolio strategists and investors. However, Bond market participants seem to grasp the concept quite well.