Markets Calm, Steady As She Goes

The global capital markets are quiet. The return of London markets has not altered the previous judgment of investors--that the weekend elections are noteworthy, but will likely keep the status quo intact. And this means the main moving part of the investment climate is what the ECB does next week.

European peripheral bond markets are holding on to yesterday's gains. European equities are also mostly higher with Dow Jones Stoxx 600 almost 0.3%, led by technology and financials. This is the fifth consecutive session that it has advanced. It is posting new six year highs. The periphery is leading the core and we note Athens is up another 1 percent.

New fighting in the Donetsk region in Ukraine appears to have knocked Russian shares lower, though Ukraine shares are holding on to small gains. The rubleUSD/RUB is softer and is near four-day lows after extending this month's recovery yesterday to its best level since January.

Despite the ongoing ECB conference and a host of officials speaking, investors still know little more than the meeting is June 5 and some sort of action will be forthcoming. Most expectations have focused on rate cuts, including a negative deposit rate and possibly some incentive to bolster lending to small and medium size businesses.

Recent media accounts quote many playing down the impact of a negative deposit rate, though we remain concerned about the potential secondary effects on money market funds and large depositors (which include corporations and the governments themselves). The impact on the real economy and inflation is a different matter, but is also most seen as marginal at best.

Meanwhile, EONIA finished last just below 40 bp, well above the refi rate set at 25 bp. Recall that the ECB's lending rate, the top of the corridor, is sitting at 75 bp. This can be lowered by the ECB and it could help lower the volatility of EONIA. At the same time, excess liquidity in the eurosystem has fallen to 81.8 bln euros - new lows (since 2011). Today's main repo operation, a 7-day facility, injects a new 42 bln euros. Given the low level of excess liquidity, injections through repo operations (and/or failed SMP sterilization) can have a greater impact than investors may have gotten accustomed to in recent quarters.

From Japan, data is beginning to show the impact of the sales tax increase. The Corporate Services Price Index rose 2.4% in April after 0.7% increase in March. The year-over-year rate jumped to 3.4%. The consensus forecast was 3.2%. However, excluding the tax increase, the headline would have fallen by 0.2% and the core would have fallen by 0.3%. Consumer prices for April will be reported first thing in Tokyo on May 30. The BOJ will look past the tax impact, which is why many observers continue to believe the BOJ will have to provide even more stimulus.

In terms of geopolitics, the year began with a focus in Asia on Japanese and Chinese tensions. Japan's Abe was quoted at Davos drawing parallels between 1914 and 2014. We suggested that China's modus operandi, and its prowess at asymmetrical responses, would imply that it would seek to make an example of another country.

We suggested it would be the Philippines, especially given its more antagonizing moves. China did try to stop a resupply ship to one of the contested islands that the Philippines apparently are using military force to secure. However, on a recent trip to Asia, it was underscored that the Philippines' claim fell within the security treaty. Logic then dictated looking elsewhere. Over the weekend a fishing ship from Vietnam was sunk near a disputed oil rig. Vietnam claims a Chinese ship rammed it. China claims the Vietnam boat rammed the oil ring before sinking.

The US reports a slew of economic data today. April durable goods orders are the most important. Weakness in Boeing (NYSE:BA) orders will weigh on the headline, but the details are likely to be consistent with a recovery in Q2 GDP. The Richmond and Dallas Fed surveys may be of little more than passing interest. The Case-Shiller House Price Index is expected to have slowed for a fourth consecutive month in March. After peaking at 13.7% year-over-year in November, the pace is expected to ease to 11.75%. Finally, over time we would not be surprised if Markit's PMI replaces the ISM data. Today Markit releases its preliminary services and composite readings. Recall that last week its preliminary manufacturing reading rose to 56.2 from 55.4 and was well above consensus expectations (55.5).