Euro Shakes But Doesn't Break. Focus Turns To US

The euro recovered from a dip to three week lows near $1.3775 after the flash CPI was not as soft as feared on the heels of the disappointing German report yesterday. The 0.7% year-over-year increase compares to the 0.5% rise in March, which had spurred more talk of QE. The decline in energy prices is still being felt as the core rate was in line with expectations, rising 1.0% year-over-year.

The soft German report was blunted by the rise in Spain's harmonized measure to 0.3% from March's -0.2% and Italy's rise to 0.6% from 0.3%. While Spain's report was in line with expectations, Italy's was a bit firmer. The important takeaway from the inflation reports is that speculation that the ECB may initiate a QE program in May seems reduced.

Moreover, a couple of other factors seem to also point to the lack of urgency by the ECB to act. These include the quarterly lending survey that suggests conditions eased in Q1 and that the economic recovery will increase demand for credit going forward. In addition, there is has been a huge injection of liquidity of almost 130 bln euros (SMP sterilization failure and net 50 bln in 7-day repo yesterday and another 8 bln via the three month repo today) that should ease pressure on the EONIA as early as tomorrow and Friday. Once again, and despite cries that words are insufficient, it appears that the ECB's Draghi has again purchased sufficient time with his verbal parry to allow investors to see the underlying signal through the noise.

Other data from the euro area was mixed, though the strength of the Spanish recovery stands out. Its preliminary look at Q1 GDP showed a 0.4% increase, twice the pace of Q4 and its strongest quarterly expansion since Q4 07. Separately, March retail sales rose 0.6% year-over-year after falling a revised 0.3% in February (from -0.4%).

This latter is particularly noteworthy as both Germany and France reported weaker figures today. German retail sales fell 0.7% in March for a -1.9% year-over-year contraction, and February's 1.3% rise was cut to only 0.4%. France's consumer spending fell 1.2%, ton a year-over-year basis which was three times worse than the market expected, even though the March gain of 0.4% was in line with expectations. The problem, as was the case in German was a downward revision to the February series.

Before leaving Europe, we note the Norwegian krone is the strongest of the major currencies, rising almost 0.7% against the dollar. It was bolstered by a much stronger than expected March retail sales report that showed a 1.0% rise. The consensus had expected a 0.2% decline. Separately, Norway indicated that it will remain on the sidelines, as it has done since last October, and not sell any krone for the sovereign wealth fund. The fund also reported that it had reduced its US Treasury and German bund holdings and increased its investment in Mexican and Brazilian bonds.

Earlier today, there were three events in Japan, where the markets re-opened after yesterday's holiday. First, it reported a softer than expected 0.3% gain in March industrial output figures. The forecast from producers for April shows a larger contraction than previously anticipated (-1.4% from -0.6%) with only a small (0.1%) rebound in May.

Second, this was consistent with the unexpectedly poor manufacturing PMI. The drop to 49.4 from 53.9 in March is the first sub-50 reading in 14 months. Output and export orders were particularly weak (46.2 from 54.2 and 49.1 from 52.3, respectively).

Third, as widely expected, the BOJ did not change its stance at the conclusion of its meeting. Its forecasts were tweaked a little (e.g. this fiscal year's growth forecast was shaved to 1.1% from 1.4%) and forecasts were extended into FY16 (GDP 1.3% CPI 2.1%). Many participants continue to look for the new efforts by the BOJ by end of July. We are more skeptical of that time frame, thinking that if the action is forthcoming it will be later, perhaps loser to the second half of the fiscal year, when it may be joined by a supplemental budget. We suspect officials have largely written off Q2, and the key will be the macro performance in Q3.

Focus now shifts back to the US. In order of timing for today, first is the ADP estimate of private sector employment. The consensus is for 210k, which would be the highest since last November. We note that Q1 was the first quarter since Q3 '12 that there was not at least one monthly print above 200k. This is a nice segue into the second event of the day, the first look at Q1 GDP. The consensus expects the economy to have expanded by a slight 1.2% (annualized pace). Outside of some knee-jerk reaction, given that the economy strengthened as the quarter progressed, and many are looking for Q2 growth to be at least twice as strong, we expect the market to look past it.

The third noteworthy event is the FOMC meeting. There is no follow-up press conference or updated forecasts. It is the statement and nothing but the statement. The economic assessment may be tweaked to recognize strengthening of activity, but it may also recognize disappointment in the housing sector. The tapering will continue with another $10 bln reduction. Here too, outside of any headline reaction, we expect investors to take the news in stride.

Yesterday, the Senate committee approved the nominations of Fischer, Brainard and Powell as Fed governors. It is expected that the entire Senate will take up the issue by the next FOMC meeting (mid-June). Today is Governor Stein's last meeting and is a reminder that there are still two vacancies on the nine-person Board of Governors. Finally, the quarterly refunding announcement will be made and, given the decline in the deficit projections, the Treasury is likely to reduce the size of the note sales.