ECB Cautiously Optimistic that Worst is Behind EMU

The substance of what ECB President Draghi contained few surprises.  The tone was cautiously optimistic that the worst is past for EMU.  

There were minor tweaks in the economy forecasts.  The growth estimate for this year and next were unchanged at 1.5% and 1.9% respectively. The forecasts for 2017 was shaved to 2% from 2.1%.  This year's inflation forecast was lifted to 0.3% from zero previously, but the 2016 and 2107 inflation forecasts were unchanged at 1.5% and 1.8% respectively.   The ECB targets "close to but below 2%," which does not look achieved until 2017.  

Ideas that the ECB could end its asset purchase program earlier was quickly dashed by Draghi.  He specifically indicated that the ECB anticipates full implementation.  Recall that every central bank that has engaged in QE had to do more (not less) than initially anticipated.  Indeed, Draghi himself  said that "if anything ECB will actually add to policy stance."  He indicated an exit was not even being discussed. 

Draghi recognized that loan dynamics have improved but that they are still subdued.  That sense seems to pervade Draghi's overall remarks.  Developments have been in the right direction, but there is much work that needs to be done.  He urges countries to pursue structural reforms to maximize the opportunity offered by monetary policy initiatives.  The ECB President made no apologies for recent dramatic market moves.  He said investors must get used to higher volatility.  

The euro briefly pushed below $1.11 but bounced back to unchanged levels near $1.1150 when no follow through selling was spurred by the break.   It was turned back from near $1.12 yesterday and again in late Asia earlier today.  Large options struck near $1.12 roll-off today.   Core bond markets, including German bunds, are extending yesterday's sell-off. 

At the same time, the US reported as expected ADP employment and a smaller April trade deficit.  Both reports are consistent with a gradual economic recovery after the Q1 contraction.   It give us no reason to question the divergence (of monetary policy trajectory) that we continue to think is a major driver of the capital markets. 

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