US – Labor market data to shape interest rate expectations

ECB – Further hints on QE

Ukraine Crisis – New sanctions possible

US – Labor market data to shape interest rate expectations

ECB Council Meeting

On Thursday, the ECB council will decide how to proceed in terms of monetary policy. Up until recently, the further course of the European central bank appeared fairly obvious. Rate cuts were already implemented in early June, the first tranche of additional liquidity through TLTROs is scheduled for mid September, and after the last meeting of the ECB council at the beginning of August, there were strong hints that an asset purchase program by the ECB involving ABS could be in the offing. However, ECB president Draghi's most recent statements have added another building bloc to the monetary policy outlook. In the course of a presentation on the European labor market, delivered at the annual Economic Policy Symposium Conference of the Federal Reserve Bank of Kansas, Draghi also interlaced remarks on inflation expectations in the euro zone. Draghi noted that inflation expectations in financial markets had declined over all time horizons in the course of August. A decline in medium term inflation expectations has long been mentioned by the ECB as a precondition for broad-based securities purchases. This refers essentially to government bonds. In his presentation, Draghi mentioned the decline of the 5 year/5 year swap rate to below 2 % (which expresses the 5 year forward breakeven inflation rate), and pointed out that this was a crucial metric employed by the ECB to determine medium term inflation expectations. The markets took this remark as a hint that an additional loosening of monetary policy was imminent, and government bond yields declined. Whether the market is reading too much into Draghi's comments, as Germany's finance minister Schäuble opined, will come to light on Thursday and there will surely be many questions on the topic during the press conference. We are inclined to expect that no broad-based asset purchase program will be announced yet. At the same time it is however unlikely that Draghi's statements were made without intent. Possibly Draghi wanted to give the markets a hint as to what they should keep an eye on, in order to gauge the probability of future broad-based securities purchases. In our view this hint has made broad based asset purchases likely, though we expect the binding announcement to come only towards the end of the year. Quarterly economic projections by the ECB staff, also scheduled for Thursday, are expected to be revised downwards, supporting expectations towards QE. In the end only president Draghi will be able to further clarify to which conditions QE will be attached and so the upcoming press conference will be followed by markets with great attention.

Ukraine Crisis

According to press reports Russian troops have entered the Ukraine to a significant extent. This would represent another step toward escalation in the conflict between Western nations and Russia. Along with that, renewed uncertainty would not only affect the markets, but also consumers and businesses in the euro zone, with potentially negative effects on the economy. One must add to this the rising probability of new, harsher sanctions, with immediate effects on demand. An EU summit takes place on Saturday, on occasion of which additional sanctions could become a topic. Be that as it may, it currently looks as though the crisis in the Ukraine could once again become a dominant topic for the markets.

US labor market data

The US payrolls report on Friday will attract a great deal of attention. The unemployment rate has declined faster than expected in the course of the past year. Should this trend continue, an unemployment rate of 5.5% could be reached in the foreseeable future, considering the most recent level of 6.2%, upon which inflationary pressures could emerge. With the Federal Funds rate currently at 0.1%, a further decline in the unemployment rate would put pressure on the Fed to take action, and therefore raise interest rate expectations, resp. move rate hike expectations forward. While Fed chair Janet Yellen has once again stressed that numerous factors must be considered in analyzing the labor market, she has concurrently pointed out that better than expected labor market trends would indeed bring the timing of the first rate hike forward.

Eurozone - economy/politics

Next week, July data for German industry production will show whether the recent weak survey data is confirmed. The already published July production data on German car manufacturers (+20% compared to last year) is quite encouraging. France’s government has been reshuffled this week. Prime Minister Valls replaced those members of the government that have not supported the reform and austerity program. This step shows that France is gradually coming to terms with reality. Due to prolonged economic stagnation, France has to pursue bold reforms. Leading indicators point to ongoing stagnation for 3Q14. For example, the August business climate index, which was published this week, declined further.