Muted Gains In Equities Ahead Of ECB

No real surprises are expected from the ECB press conference today. Encouraging signs of growth and improvements in manufacturing output in the Eurozone should vindicate Draghi’s current monetary policy stance but questions will be asked about recent volatility in debt markets. The rally in the single currency yesterday will not sit well and while a deflationary climate seems to be off the cards for now, it’s reasonable to expect that the overall tone will be dovish. Given the rate of change in consumer prices over the past 5 months, there is a possibility that inflation forecasts will be revised higher.

The Eurozone unemployment rate is apparently also going in the right direction. It’s expected to tick down to 11.2% from 11.3%. Retail sales for May in the single currency zone are also predicted to rise by 0.7% mom. Given the current fundamentals and ignoring Greece for a moment, this euro rally may not yet be over.

As is normally the case in non-farm payroll week, equity index moves are rather muted this morning with repressed investor appetite. Consumer staples are in vogue with Morrison's (LONDON:MRW) the top riser on the day following its first sales rise in 18 months. Some of this upside can be attributed to the FTSE reshuffle and rumours that Morrison’s will be relegated to the FTSE 250 later this evening.

The UK utility sector outperformed the Stoxx600 in May in the aftermath of the general election. An element of profit taking is setting in now with National Grid (LONDON:NG), Centrica (LONDON:CNA) amongst the worst performers on the FTSE this morning.

Macro data for the UK has been, for the most part, firing on all cylinders. Yet service output, which makes up almost 80% of overall GDP, has failed to continue the trend. Missing expectations, the service output fell to 56.5, its lowest reading since December. The index has, however seen 29 consecutive months of expansion.

The Dow is slated to open up 22 points at 18033.

Given that last month’s number failed to impress and thus often seen as bellwether for the more closely watched non-farm payrolls number, the ADP employment change is expected to show that 200,000 private jobs were added in May. Any failure to meet the consensus could add to the spiralling downside moves in the greenback.

The euro bulls face event risks: ECB, Greece

EUR/USD's aggressive rally appears to have taken the market well beyond itself. As the core inflation estimate advanced to 0.9% y/y in May, the speculation that the ECB could end its QE before September 2016 has been the major source of euro’s bull market; heavy headwinds hit the Eurozone sovereigns. The ECB meets today and is certainly fully prepared to deny any possibility for an early exit from the bond markets.

The ECB-induced distortion continues having a dramatic impact on German sovereigns. The German 10-Year yields surged to 0.74%. Since mid-April, long maturity German bunds are subject to high volatilities and the unusual price action in German bund market wanes all anticipation that the longer maturity yields may cross below zero. There is little sense paying to carry risk, even if we talk about German risk. In fact, the risk premiums paid in the market are fully decoupled from the effective country risks nowadays; a German bund has become, thanks to the ECB, as risky as any peripheral country. If this is the price to pay to bring the inflation back in the Eurozone, the game has just started. The volatilities in Eurozone sovereigns can only go higher with 60 billion euro worth of papers being pulled out of the market by the ECB every month. The instability could be a major drawback of ECB’s ‘magic’ QE.

Greek risks prevail

Whether the euro rally was a simple momentum game following better-than-expected Eurozone CPI, or sudden (unnecessary) optimism on Greece, or even the consequence of triggered stops above 1.1050, 1.1100 and 1.1150, the grey clouds over Greece do not seem to have disappeared and the event risks prevail on the EUR-complex.

As June 5th repayment date approaches dangerously, we have not heard about any deal being sealed between Greece and the EU yet. There is great chance that a rapidly wrapped emergency deal, if any, remains a temporary solution. The event risks prevail, even if the euro market seems too busy with the inflation euphoria to price the Greek default risks in.