Daily Kickstart (ECB Preview; Why Did Tarzan And Suicide Squad Suck So Bad?)

It feels quiet out there on Thursday morning.

On Wednesday, a fairly potent one-two punch from CPI data and Janet Yellen (she’ll speak again on Thursday evening) pushed Treasury yields higher across the curve and I for one, will be watching to see the market’s reaction to comments from Trump Treasury pick Steven Mnuchin who faces a Senate Finance Committee confirmation hearing on Thursday.

They’ll be plenty of questions about OneWest (formerly IndyMac) and foreclosure practices.“Since I was first nominated to serve as Treasury secretary, I have been maligned as taking advantage of others’ hardships in order to earn a buck,” Mnuchin’s prepared remarks for the hearing read. “Nothing could be further from the truth.” The former Goldmanite is also a Hollywood financier and if there’s any justice, someone at the hearing will ask him why “The Legend of Tarzan” and more recently “Suicide Squad” sucked so bad. Especially considering he’s listed as an executive producer of some much better films including “American Sniper” and “Mad Max: Fury Road.” So that’s something to ponder.

Ok, anyway, the Nikkei rose nearly 2% overnight on a weaker yen.“The dollar had been sold in an excessive reaction to political issues recently, but that was reversed as Yellen’s comments reaffirmed that the U.S. remains on course to raise interest rates,” one trader told Bloomberg, referencing the dollar’s violent reaction to Trump’s comments in the Wall Street Journal published on Tuesday. Chinese shares fell, but don’t worry, they won’t be allowed to fall too far. “Chinese markets are likely to fluctuate ahead of the Chinese New Year instead of showing a clear direction either way,” Linus Yip, a strategist at First Shanghai Securities Ltd. in Hong Kong said. “Investors expect the Chinese government to continue stabilizing markets before the holiday.”

MSCI Asia Pacific down 0.2% to 140
Nikkei 225 up 0.9% to 19072
Hang Seng down 0.2% to 23050
Shanghai Composite down 0.4% to 3101
S&P/ASX 200 up 0.2% to 5692

In Europe, stocks are lower as markets await Mario Draghi. The ECB meeting is expected to be a relatively quiet affair, but that hasn’t stopped FX vol from spiking as it usually does ahead of meetings:

(Bloomberg)

“Our central case scenario is a patient ECB,” Deutsche Bank wrote, in a note out late last week. “They should be reassured by broadly unchanged financial conditions after their decision to slow the pace of QE.”

Citi agrees. “Today’s ECB meeting is too close to the policy moves enacted last month to warrant a material shift in ECB tone in our view, even if data has been more buoyant than expected,” the bank said a few hours ago, adding that “we think that any further tapering risk starts from June meetings onwards but the rise in oil prices and a drop in the EUR FX could see markets re-price from the March Staff forecasts.”

Citi also wants you to watch the language around increasing the issue limits on asset purchases as this could become a constraint with bunds if there’s an extension past 2018. There’s also a risk that if the issue issue (and yes, there are supposed to be two “issues” there) isn’t addressed, “whatever it takes” may not really mean “whatever it takes.” Here’s Citi:

We stress that the 33% issuer limit discussion is very profound because:

Its means a 6m extension of PSPP into 2018 is not possible as Bunds hit that limit in May18.

More significantly, this is a regime shift for the periphery to wider levels because it unwinds Draghi’s ‘whatever-it-takes’ comment in 2012. It effectively moves periphery bonds from sovereign-space towards external-debt valuations.

Clearly, there is no crisis, and so the case for much wider spreads is not present but H2-17 will be more challenging for periphery valuations as an extra risk premium is warranted on the ECB’s limitations.

Of course the inflation outlook is also key here. Consider the following additional color from Deutsche Bank:

However, normalisation is being dominated by energy and food inflation; core inflation remains “unconvincing”. If we take Q2’16 as the low point of the inflation cycle, the rise in headline inflation has been 1.2pp. The rise in core inflation has been a mere 0.1pp. Confidence in the feed through of rising headline into core will build as the rise in headline holds, for example, indexation effects will start to kick-in and lend momentum to core inflation. Nevertheless, for now the rise in core inflation is limited.

In Q4, one of the ECB mantras was how “unconvincing” core inflation was. This caution was echoed in the ECB minutes of the December meeting and again in comments in an interview by ECB Board Member Benoit Coeure over the holidays: “we are still waiting for signs that core inflation is on the rise and will clearly exceed 1%”. Coeure added that “our assessment of the balance of risks is shifting” but he was referring in a backward-looking sense to the decisions taken in December. It was not a forward-looking statement preparing the ground for a further adjustment in tone on 19 January.

It is important to understand that inflation is still only “normalizing”. It is still below normal. For example, since 1999, core HICP inflation has been above current levels 80% of the time. What this means is the rise in inflation expectations and forecasts has a lot more upside. The implied 5Y inflation rate has increased from a trough of 0.6% in early 2016 to about 1.2% recently, for example. If headline inflation is likely to exceed that this year and normalization is a fact, the implied inflation rate has further to rise.

In the end, the market managed to take December’s pseudo-taper in stride…

(Chart: Deutsche Bank)

…and with Janet Yellen doing all the work (via perpetuating the growing policy divergence between the Fed and the ECB/BoJ) it probably doesn’t make sense for Draghi to rock the boat in January. So expect his commentary to be on the subdued/cautious side.

Oh, and as always, watch for cute girls with confetti bombs…