Comey lets loose, Draghi hangs loose
Comey characterized Trump as untrustworthy, manipulative and liberal with the truth. But that is who a minority of Americans voted in as President. Is Trump inexperienced in public office? Is he used to running the show and getting his way? Tick and tick, nothing new here either. Comey offered plenty of salacious detail and did a good job of protecting his own legacy, but offered nothing that should really surprise. Trump did not directly ask Comey to stop investigating Flynn, and Comey offered no evidence that he wanted the broader investigation into Russian election meddling or collusion with the Trump team stopped. The poor political performance of Trump continues to undermine confidence, but political risk should not rise further. ECB President Draghi did a good job dampening expectations that monetary accommodation will be wound back much in coming years. He raised the outlook for growth, said deflation risk had disappeared, and expressed more confidence in the ECB’s inflation forecasts. However, the ECB downgraded its inflation outlook and emphasized a gradual improvement, held back by ongoing low wage growth. Draghi emphasized that the ECB will be in the market for a long time; suggesting asset purchases will be tapered slowly and rates held at present levels beyond that. The lower rates outlook will serve to keep EUR upside contained. However, the ECB outlook should support growth and equities, which are doing more to drive many currencies this year than rates and yields.
ECB downgrades inflation outlook, but is more confident it’s on the right path
The ECB had two less dovish elements; it removed the bias to cut rates, and it moved from a downside bias to a balanced outlook for growth.
It also included a more dovish element; it lowered its inflation forecasts, reducing the chances that it will normalize policy very much within the next two years.
On balance, the market reacted more to the dovish element, although the fall in Eurozone rates and the EUR were relatively modest.
The less dovish elements help account for much of the rebound in the EUR over recent weeks and were more anticipated. The cut in the inflation outlook was rumoured in recent days and did cause a brief dip in the EUR on Tuesday. It has probably helped cap the EUR in the face of a weaker USD recently, and it has contributed to some fall in the EUR following the ECB press conference today.
10 yr German bund yields fell by around three basis points after the presser, while US Treasury yields were relatively stable. Eurozone 2yr swap rates fell about 1.3bp, US 2yr swap rates rose somewhat.
EUR started to slip ahead of the ECB press conference, and slipped further afterward. Although it has been relatively contained moving from mid to low 1.12s
The ECB introductory statement continued to say that it expects rates to “remain at present levels for an extended period of time, and well past the horizon of our net asset purchases.” But it removed the “or lower” from previous 27 April statement.
Draghi said this shift in guidance was linked to an assessment that the “tail risks” for its inflation forecast had been removed and the risk of deflation had “disappeared”.
This is probably of little concern to the market that has been looking for evidence that rates might rise sooner, and not anticipating any further cut in rates. As such, this less dovish element probably had little impact on the market.
The ECB removed the remaining view that there were greater downside risks to the economic recovery. In April, it said, “downside risks have further diminished”. Today it said, “the risks to the growth outlook are now broadly balanced.”
However, it said, “At the same time, the economic expansion has yet to translate into stronger inflation dynamics.” And it restated that, “a very substantial degree of monetary accommodation is still needed”.
Furthermore, it restated its preparedness to “increase our asset purchase programme in terms of size and/or duration”, if the outlook deteriorates.
The growth forecasts were upgraded: In 2017 from 1.8% to 1.9%, in 2018 from 1.7% to 1.8%, and in 2019 from 1.6% to 1.7%. This is well above the potential growth rate of around 1%.
However, more importantly for the single (inflation) mandated central bank, it downgraded its inflation forecasts. Draghi emphasized that the outlook for underlying inflation had hardly changed, but even the underlying inflation forecast for the coming two years was downgraded a touch.
The headline inflation forecast was downgraded: in 2017 from 1.7% to 1.5%, in 2018 from 1.6% to 1.3%, and in 2019 from 1.7% to 1.6%
The underlying inflation forecast was slightly downgraded: unchanged in 2017 at 1.1%, in 2018 from 1.5% to 1.4%, and in 2019 from 1.8% to 1.7%. This is still below, but getting near the just below 2% ECB inflation target at the end of its forecast horizon.
Draghi emphasized that while the ECB was more confident on the outlook for growth and the path for inflation to converge to its target, it expected underlying inflation to rise only very gradually.
He noted that most of the variation in inflation outcomes had come from oil and food prices and the underlying rate had hardly moved much since last year, and indeed over recent years.
He explained that the flat underlying inflation profile reflected subdued wages growth, structural changes in the labour market, and more backward-looking wage negotiation behavior.
He noted that the recovery is generating strong job growth and strong growth in the labor force and participation, but said that many of the new jobs are “low quality jobs”; in that, they are temporary and part-time jobs. He said, so much so that the ECB has developed broader measures of unemployment [as has often been discussed by the Fed and other central banks in recent years].
He also noted that structural reforms are making the labour market more flexible resulting in lower nominal wage growth than might have occurred in past cycles.
He noted that we need to be “patient” in waiting for wages growth and inflation to return. But he also said we need to “confident” that it will. Draghi is essentially trying to damp down expectations that policy normalization will occur very quickly.
He said there were two dimensions to the uncertainty surrounding inflation. The first dimension is the tail risks, or the risk of deflation; this has disappeared, and why the ECB has removed the bias to cut rates. The second is the uncertainty in the path of inflation; he said this had also decreased and we are becoming more confident that inflation will converge to the target in a durable way.
As such, even though the inflation forecast was lowered, the ECB has narrower probability bands around the inflation path.
However, Draghi said that he wanted to “emphasise that the ECB will be in the market for a looong time” [he dragged out the long for emphasis].
Draghi said that the Governing Council did not discuss normalization and offered no indication that this might be discussed at the September meeting; where most market participates expect to hear plans for the Asset Purchases beyond the current program that ends in December.
Comey opens a window into the heart of Trump
The other big news today was the testimony by Comey. The USD and rates market were remarkable calm during the testimony that delivered plenty of salacious headlines over Comey’s interpretation of intimate conversations with President Trump.
The news media will be feeding on this junk-food like squabbling seagulls for weeks. Comey basically characterized the President as a manipulative untrustworthy liar. He has come out swinging since being fired and is hardly taking it on the chin.
This will not help the President get his policy agenda back on track and will only intensify, already intense, Congressional focus on Russian election meddling.
However, as damning is Comey’s testimony is on Trump’s character, and assessment that Trump tried to influence the FBI’s investigation into former National Security Advisor, Michael Flynn (i.e. have it stopped); Comey could not say he was directly asked to stop it.
Most would agree there is nothing here that could give clear cause for impeachment proceedings. Trump also never clearly tried to discourage the FBI investigation into Russian election meddling or collusion with the Trump team, according to the Comey’s testimony
Questions remain, such as why Trump wanted to protect Flynn so much as to make inappropriate requests of the FBI director. But at the end of the day, most of Comey’s claims against Trump point more to a lack of experience in public office and a style of management that evolved from a history of calling the shots and getting his own way. That Trump is liberal with facts and the truth is hardly news to anyone.
As such, the Comey testimony may ruffle a few feathers but level of political uncertainty in the USA should remain the same, albeit elevated….for now.