Article / 28 June 2017 at 3:34 GMT

Triple header inflation updates to test Draghi, Yellen and Kuroda

Managing Director / Technical Research Limited
New Zealand
  • Markets have reacted to Draghi’s new-found confidence in the outlook in the EU
  • Energy is making a declining contribution to inflation, after oil gave up its gains
  • Inflation data is unlikely to be supportive of Draghi,  Yellen or Kuroda
By Max McKegg

Central bankers are out in force this week, basically telling the markets “Trust us, we know what we’re doing”. But the proof will be in the pudding and we will get a taste test on Friday when the latest inflation reports from the US, the Eurozone and Japan are released. While economic growth is picking up in the Big Three economies suggesting it’s time to tighten monetary policy, inflation remains the missing link.

Speaking at a forum on Tuesday, European Central Bank President Mario Draghi said that “All signs now point to a strengthening and broadening recovery in the euro area – deflationary forces have been replaced by reflationary ones”.

nnn



















While the Bank of Japan hopes that inflation to reach 2%, the consumer price index is likely to put its head above 0% for May, but only just. Photo: Shutterstock

However, Friday’s Eurozone inflation numbers won’t provide much support for his positive outlook. Expectations are that the headline rate will be shown to have slipped to 1.1% on an annual basis, a long way off the 2% seen earlier in the year.

As the following chart shows, the culprit will be a declining contribution from the energy sector as oil prices give up last year’s gains.

 
Nordea EU inflation chart
nnn



















Source: Nordea. Create your own charts with SaxoTrader; click here to learn more. 

Draghi knows the May inflation update will not look good on the surface, and so issued his defence in advance saying “there are still factors that are weighing on the path of inflation. At present they are mainly temporary factors that typically the central bank can look through”.

In other words, for the ECB the core inflation rate, not the headline, will be of most interest. They will be hoping the market forecast is correct and the core rate will be shown to have crept up to 1% year-on-year from 0.9% the previous month.

Financial markets have reacted to Draghi’s new-found confidence in the outlook, pushing EURUSD up to 1.1345 in Asian trading and the yield on the 10-year German bund up 13 basis points to 0.37%. Analysts are expecting the ECB to begin tapering its bond buying program early in 2018 and to be out of the market completely by mid-year, at which point the deposit rate will be raised by 10 basis points from -0.40% to -0.30%.

Federal Open Market Committee chair Janet Yellen also spoke on Tuesday, at a less formal question and answer session in London. In a similar position to Mario Draghi, she will know that Friday’s price index of Personal Consumptions Expenditures, the Fed’s preferred inflation measure, will not be good news, the scene having been set by a surprising fall in the Consumer Price Index earlier in the month.

The following chart shows the current position for the PCE. Expectations are that the annual headline rate will slip again to 1.5% and the core rate to 1.4%.

Personal consumption expenditure trend
nnn





















Source: Advisorperspectives.com

Ahead of the release, Yellen’s comment was “what we would worry about is if it looked like inflation expectations were slipping because that could make low inflation become endemic and ingrained. So we certainly want to avoid that”.

Many will point out that it is not a question of “if” inflation expectations will slip; they already have, as shown in the following chart of the break even rate based on a comparison of the yield on 10-year maturity US Treasury bonds and the inflation protected equivalent (TIPS). Investors are buying TIPS on the basis that inflation will average only 1.65% over the next decade, well off the 2% plus they were prepared to bet on a few months ago.

US inflation expectations
nnn



















Source: Financial Times

Bank of Japan Governor Haruhiko Kuroda will be part of a star-studded central bank panel later today, but he is unlikely to offer any fresh insights into monetary policy. That’s because Friday’s inflation numbers from Japan’s statistics bureau will not change the outlook that inflation is likely to remain low “for the time being”.

Nevertheless, there may be a glimmer of hope in the May Consumer Price Index numbers: the BoJ’s benchmark rate is expected to crawl up to 0.4% from 0.3% on an annual basis and the core rate (excluding energy) to put its head up above 0% – just.

As in the US and Eurozone, the economic situation in Japan is improving and according to the BoJ “the year-on-year rate of change in the CPI is likely to continue on an uptrend and increase towards 2%, mainly on the back of an improvement in the output gap and a rise in medium to long term inflation expectations”.

But in the meantime Kuroda will stick with his yield-curve-control policy, holding the deposit rate at –0.10% and the 10-year government bond yield at “around zero percent”. USDJPY has been taking its lead from the US versus Japan bond spread for some time. The correlation weakened a little last week but seemed to have been re-instated after US bond yields followed German bund equivalents higher yesterday, taking USDJPY along for the ride, as shown in this chart (please click to enlarge)

USDJPY chart
nnn
 
Source: Metastock

The European Central Bank and Bank of Japan been pumping out a combined $300 billion of liquidity per month via their QE programs, enough to support financial markets even as the Federal Reserve prepares to wind down its own book.

But inflation is the Achilles heal of each central bank and while they are putting a positive spin on the outlook for prices, the evidence to be presented on Friday is unlikely to be supportive.

– Edited by Robert Ryan

For more on forex, click here.

Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.


2y
Patto Patto
The Fed's senior leadership - Yellen, Fischer and Dudley - seem to co-ordinating warnings that the stock market is too high...
2y
Max McKegg Max McKegg
That's right Patto. The Fed is taking away the punchbowl but no one wants to leave the party. I hope they don't all decide to do so at the same time!

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail