No peashooters please

After Monday’s weaker than expected German CPI report, Tuesday’s eurozone inflation report duly failed to meet low expectations. May’s core inflation rate came in at 0.7% against hopes of 0.9% and the previous month’s 1%. Tuesday also saw the release of April’s eurozone unemployment rate, again to no great surprise the figure stays stubbornly high at 11.7%. Something we have highlighted on more than one occasion is the current gap between the strength of the French and German economies. Unless this gap is not recognized and French pride continues to be dented, strains on the euro could easily reappear.  One chart that we believe illustrates clearly the gap between the two economies is the difference between French and German consumers mood as demonstrated here.

There was a muted reaction in the equity markets to the latest eurozone data, part probably due to the lack of surprise, along with investment banks and professional investors not wanting to, or encouraged to make new decisions ahead of Thursday’s meeting. The Telegraph on Tuesday, as they anticipate what the ECB might do, described the likely outcome as bringing a peashooter when a bazooka is needed, probably summing up the likely events on Thursday pretty well.

In the first sign of volatility for a while in an asset class, 10-year US treasury yields rose sharply on Tuesday to 2.6%. The recent focus has been on the fall in yields and there have been several theories put about by so called experts as possible causes. As the market anticipates the Federal Reserve withdrawing another $10bn of liquidity at the next meeting, a sudden sharp rise in yields will also have implications for equity investors. 

In Europe, for choice, bond yields also rose as investors speculate Tuesday’s data could encourage the ECB to be more proactive with their policy initiatives. As we repeated last year in our blogs ahead of the Federal Reserve’s announcement of their intention to taper the bond purchase program, equity markets take their lead from the bond market. The reaction of the peripheral bond market to Thursday’s meeting, along with that of the euro, will go along way determine equity investor’s reaction. We have always believed that the ECB will only release the bazooka when and if peripheral bond yields start to rise in a material way once again.

Posted on June 4, 2014 .