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Strong acceleration of headline inflation, factor that could support a potential ECB tapering

09 January 2017

The year starts just like 2016 ended, with solid growth data almost everywhere and positive leading indicators.

As an example :

  • US non-farm payroll: job creations as expected but with higher wage growth at 2.9% YoY, this confirms rising tensions in the labor market and is pushing the Fed to be less accommodative
  • Euro Area Inflation: 1.1%, slightly above expectations (with German inflation at 1.7%, way above expectations). This matters for many reasons: on the one end it reaffirms deflation risk has almost disappeared in the Eurozone, on the other end this could put ECB into a difficult position if German inflation continues to go up. German authorities are beginning to make more noise regarding that topic, arguing that Germans earn -2% real rate on their deposits. In short, the probability to have an early taper has increased, and that is not priced in markets

Interestingly this year we had the now notorious tweets from Mr. Trump who makes announcements regarding China, Mexico, GM… and made Ford cancel a plant construction in Mexico. We will have to get used to it; some people have already developed algorithms based on these tweets…

The consequence of a stronger dollar and outflows from China is that the monetary market is under pressure in China. Authorities have intervened boldly to punish short sellers in hiking massively repo rates. The objective is to dampen capital outflows and to reduce Yuan depreciation. The move have worked over the last two days with Yuan recovering strongly, but it will be difficult to hold if the dollar continues to appreciate.

Now that most important data is out for the month, investors will focus on :

  • Earnings season in the US which starts on January 13th
  • Trump gets into the office on the 20th
  • Central banks of course with ECB starting on the 19th

In terms of market views, this strengthens our bearish view on Euro area core fixed income, which is expressed significantly in our portfolio. Equity markets may continue to grind higher, but recent performance and high expectations reduce short term potential to our eyes, even if on the macro side, all is going into the right direction. We continue to have mixed feelings about the dollar which remains expansive and is heavily owned.

Kind regards.

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