Reflation story will look much different three months from now - BBH

Marc Chandler, Global Head of Currency Strategy at BBH, anticipates that the reflation story will look much different three months from now as the survey data, such as purchasing managers and consumer confidence, appears to be running ahead of actual economic performance while the credit expansion in the euro area remains paltry. 

Key Quotes

“The reduction of the current account surplus in January, the most recent data available, warns of the risk of slower growth.”

“The rise in headline inflation remains mostly the result of higher energy prices and weather-related seasonal food prices.  Core inflation has been extremely stable, a little above the 0.6% trough at 0.9%.  The calls playing up the possibility of a deposit rate hike (from the current negative 40 bp) appear to have come from those parties that have not been particularly supportive of the ECB’s monetary policy, such as in Germany and Austria.”

“Contrary to the oft-repeated claim, Germany does not dictate the European monetary policy, even though it is the single largest member.  The German central bank and the finance ministry leave little doubt that they would prefer a less accommodative monetary policy stance.  The central bank even participated in a court case seeking to overturn the ECB’s stance.  ECB President Draghi may be right that Germany’ ordo-liberalism is part of the central bank’s DNA, but that does not mean its interests determine policy.”

“The ECB’s exit strategy has not been mapped out.  The March ECB press conference and updated staff forecasts suggest that should the penalty rate on deposits be reduced, it will not be a Q2 decision.  Moreover, a reduced penalty would not necessarily impact the more important refi rate.”

“In the UK, while inflation may not peak until the end of Q2 or early Q3, the real economy is set to slow, and this will likely prove sufficient to keep the BOE on hold.  The lone dissent from steady policy in March, Kristin Forbes, will step down at the end of her three-year term in June. Poor wage growth suggests a headwind on demand and a check on price pressures going forward.”

“While the BOJ has adjusted the implementation of its unorthodox monetary policy, price pressures remain practically non-existent in Japan, and even with fiscal support, the economy languishes. Wage growth has been miserly and household demand poor.  Domestic returns are too low for savers, and although the Japanese were net sellers of foreign bonds over the past quarter, we expect that they will return in Q2.”

“We suspect the possibility of a June US rate hike is higher than the one-in-three chance the market currently assesses.  We expect the US economy to recover from the soft patch in Q1, led by stronger consumption and supported by continued job and wage growth.  The recovery in oil prices and the deployment of more rigs may underpin manufacturing and business investment.  The Federal Reserve is still likely to hike its Fed Funds target range at least a couple more times before other major central banks hike.  Despite the wobble, we do not think peak divergence has passed.”