Inflation expectations are tumbling along with stock markets

Market Movers

• We expect Mario Draghi to express a patient view at the ECB meeting today, as he needs to balance the views of the doves as well as the hawks. The very low oil price and in particular falling inflation expectations are threats to our expectation that the ECB has delivered the end of easing. However, given that the market already prices in a relatively high probability of additional rate cuts, today’s meeting could be a disappointment if Draghi does not point to further rate cuts. For details, see ECB preview: two camps – both with stronger arguments (19 January).

• Before the ECB policy announcement, the final euro-zone inflation numbers for December will also be released. We expect the December figure to be unchanged at 0.2% y/y but note that we still expect inflation to increase to 0.5% y/y in January.

• The weekly US oil inventory data will be in focus for the oil market oil as over-supply remains a strong negative factor for the oil price.

• In Denmark, consumer confidence data for January will be released.

Selected Market News

It has been a relatively quiet session overnight in terms of news releases and growth concerns and poor risk appetite continues to dominate financial markets. The negative momentum in risk assets eased during the US session and the SP500 index closed 1.2% lower after being down as much as 3.6% at some point. Yields on 10-year US treasuries have dropped nearly 30bp since the beginning of this year and dropped below 2% and temporarily touched 1.94% last night before bouncing some basis points higher along with a rebound in equities. In Asia this morning, sentiment is once again turning weak and most regional indices are trading in the red.

Inflation expectations are tumbling along with stock markets and investors are looking towards the major central banks for support and responses to the recent oil price declines and falling growth and inflation expectations. 5Y5Y break-even inflations trade at 1.92% in the US and 1.575% in the euro area adding pressure on the major central banks’ credibility. Today, Draghi will be tested in the hot seat. As mentioned above, we think there is a risk that he might disappoint given the market’s pricing of additional rate cuts. However, even if he manages to deliver, it is highly questionable whether the ECB alone has the ammunition and ability to reverse the negative sentiment on its own. Hence, after today’s ECB meeting, focus will turn to the FOMC meeting on 27 January and the Bank of Japan’s (BoJ) meeting on 29 January. In respect of the BoJ, the probability of additional easing has increased on rising concerns that the ‘shunto’ spring wage negotiations may disappoint and as yen appreciation and the lower oil price weakens the near-term inflation outlook. Bank of Japan Governor Kuroda this morning re-iterated that the BoJ has sufficient tools for more easing and is watching carefully the effect of markets on the economy and prices.

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