ECB is confusing investors, expressing concerns about excessive strengthening of the single European currency
The market is ruled by the big money, and long stability is a destabilizing factor. Throughout the years of the central banks’ ultra-soft monetary policy, calm has returned to the markets. Cheap liquidity within QE allowed stock and bonds to grow simultaneously, and with their growth, large player were actively hedging against the risks of rollback with, betting on low volatility. According to Evercore, about $2 trillion was invested in such strategies. VIX was sleeping soundly at the bottom until there was a clap of thunder in February.
A mixture of cheap money policy and fiscal incentives is a deadly combination, allowing to expect a sharp surge of consumer prices, four hikes of federal fund rate in 2018 and 10-year Treasury yields growth up to 3.5% in 6 months. Exactly this figure is reported by Goldman Sachs, paying no attention to its substantial deviation from Bloomberg experts’ consensus forecast (2.95%). Capital inflow of $859 trillion into the funds, investing in U.S. Treasury inflation protected securities (TIPS)during the week ended February 7, which is the largest since November, 2016, is another proof that investors are seriously concerned about CPI and PCE growth.
On the other hand, The Fed has been claiming throughout the years that strong labour market will speed up the growth of consumer prices. If Phillips curve doesn’t work, why should the chain “the tax reform-inflation growth” work? JP Morgan sees no signs of inflation pressure, and Financial Times experts predict that CPI will slow down from 2.1% to 1.9% in January, core indicator will decline from 1.8% to 1.7%
Dynamics of U.S. inflation
Source: Financial Times.
If their projections come true, S&P500 bears may lose their energy soon. Moreover, according to Morgan Stanley, from the point of view of P/E, the stocks at the current levels start looking too cheap. Another matter is that euro has also much do deal with.
The political uncertainty is shadowing Eurozone. That resulted from the approaching Italian elections, unsettled issue of the coalition in Germany and the ECB concerns about strong currency. These factors make investors be extremely careful about buying EUR/USD. Anyway, According to ING, the ECB is muddying the water. Although, euro rate has increased against U.S. dollar by 15% in the last 12 months, euro trade-weighted exchange rate has hardly changed since August, 2017.
Dynamics of euro trade-weighted exchange rate
Source: Financial Times.
Thus, the Governing Council has no reasons for projections of HCPI decline, which EUR/USD bulls are so worried about. In general, I still expect the main currency pair to consolidate in the range of 1.217-1.243 until the report on the U.S. inflation for January is released.
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