Draghi’s Sparks Mini Taper Tantrum, Euro Chief Beneficiary

Sounding confident, ECB President Draghi seemed prepared to reduce the
asset purchases, and this overshadowed
his explicit recognition that substantial accommodation is still
  This is very
much in line with what many, including ourselves, anticipate:  At the
September ECB meeting, an extension of
the asset purchases into the first part of next year, coupled with a reduction
in the amounts being purchased.  

The yield on the German 10-year Bund finished last week near 25 bp. 
Today it briefly traded as high as 40 bp.  
Peripheral European bonds got crushed yesterday, but
seemingly, the quest for yield brought in buyers today, and Spain, Italy and
Portuguese yields are lower today, while the core is firmer.

Also, consider other elements of the news stream.  The French
cabinet is expected to approve Macon’s new labor code, which is hoped to be
approved by parliament in September.  Consensus thinking is that the
rigidities in the labor market are undermining French competitiveness. 
Macron proposes limiting severance pay and the costs of dismissing employees,
simplify worker representation, and make companies,
not industries the key bargaining unit. 

There are two risks here.  First, that Macron does not get what he wants.  After all, he is not the first
French President to push for labor reforms.  Sarkozy and Hollande both
tried, but unions and others successfully resisted.  Second, Macron can
get what he wants but finds that the
reforms were oversold and that the key to
French competitive is not so much about cutting labor costs, but in the
flexibility of capital; incentives for entrepreneurship,
innovation, and incentives for profit-seeking instead of rent-seeking behavior

Eurozone money supply and lending figures were
  M3 growth improved to a 5% pace.  It has
averaged 5% over the past six months.  Lending to non-financial businesses
was steady rising  1.6% year-over-year, roughly in line with GDP
growth.  Lending to households improved a 2.7% pace from 2.6%.  

Still, we suspect the market is getting ahead of itself.  The
key to ECB policy is not growth but inflation.  Italy is the first to
report the flash June figures.  The EMU figure will be released at the end of the week. 
Italy’s harmonized measure of CPI was weaker than expected.  It fell 0.2%
for the second consecutive month, which brings the year-over-year figure to
1.2%.  The lowest since January.   


Also, even if market sentiment
looks at the money supply growth and credit expansion through rose tinted
glasses, the sharp decline in the credit impulse–the second difference of the
stock of credit.
  It was especially weak in Italy, and this may have been a reflection of its simmering banking
woes that came to a head in recent days.  

We also suspect that many observers exaggerate the impact on yields of
central bank buying.
  Numerous studies find that more important
channel is the signaling effect, not the
purchasing.  The reason the price of money is low, we suggest, is not
simply because the ECB and BOJ are buying bonds, but also, and more
importantly,  the supply of capital outstrips its demand.  Capital is
subject to the same laws of supply and demand as other commodities.  Low
inflation, low growth, excess capacity in numerous industries, all serve to
dampen the price of capital.  

At the same time, the news stream from the US has deteriorated. 
The delay in the healthcare vote in the
Senate sours the outlook, many suspect, of the other parts of the Republican
agenda of tax reform and infrastructure spending.  The Republican strategy of bypassing the Democrats, which some suggest is
an exercise in realpolitik and the power of the majority, appears to have the
same problem in the Senate as it did in the House of Representative: 
namely that the Republican Party, like all modern parties, is a coalition, not
a homogeneous group.
  What appears to the moderates alienates the

In this vein, the IMF revised down its growth forecasts for the US
economy this year and next.
  Like the market, it is skeptical about
the US ability to enact tax reform and infrastructure spending.  It is
skeptical that the Trump Administration will be able to boost
growth.     The market is skeptical about the Fed’s ability
to hike rates again this year.  Interpolating from the OIS, the market
appears to have discounted a 40% chance of a hike before the end of the
year.  Moreover, looking at the curve, the odds of a hike (to bring Fed
funds to 1.25-1.50%) peak in March next year (~41%) and then ease. 

The Canadian dollar is the strongest of the major currencies today,
gaining almost 0.5% against the US dollar. 
It is trading at its best
level in four months and is approaching congestion near CAD1.3100.  The
driving force continues to be a reassessment of the trajectory of policy. 
Bank of Canada Governor Poloz noted that interest rates have down their job and
are extraordinarily low.   The Bank of Canada meets July 12.   

The Canadian dollar is resisting the pull of oil prices.  The
four-day rally is at risk today, following news late yesterday from API that
showed an 850k barrel build in oil
inventories, and news that OPEC output appears to be increasing.  Initial
support is seen near $43.50 basis the
August light sweet crude futures contract.  

The US economic diary includes the
advance report on merchandise trade (look for a slightly smaller deficit),
wholesale and retail inventories (for GDP calculation, look for a small boost),
and pending home sales ( an improvement
over April likely).
   There continues to be headline risk from the ECB
conference that ends today.  Draghi, Carney, Kuroda, and Bernanke are on tap.    Investors also
will continue to digest the seeming campaign by the Fed’s leadership, Yellen, Fischer, and Dudley, as well as some other Fed
officials, expressing concern over either the US financial conditions or the elevated stock

Yellen’s claim that there may not be another crisis in our lives was ridiculed It may seem overly
optimistic, but she is not talking about a cyclical downturn as in a recession,
but a crisis of the magnitude of the
Great Depression or the Great Financial Crisis.   There seem to be 40-50 years between such crisis
since at least the middle of the 19th century, though, of course, some cycle work (see Kondratieff Wave)
would project it much further into the past).  


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