Geopolitical Risk Derails ECB Plan Market Awaits FOMC

• IMF cuts 2014, longer-term U.S. growth forecasts
• Iraq and Ukraine heat up geopolitical risk VIX rose from 3.86% to 12.65%
• European inflation confirmed low at 0.6%

Euro strengthens boosted by safe haven flows.

The European Central Bank decision to turn to negative deposit rates had limited effect. The policy had the intended result and started weakening the currency below 1.36, but geopolitical events changed the economic landscape. The EUR had proven resilient to the Ukraine turmoil but the Iraqi insurgency proved to much. The USD has lost some of its appeal as a safe haven so the EUR recovered and even the inflation data confirming the deflation fears could not bring it below 1.3550. Eurostat released inflation figures today. Deflation continues to be a the rate of inflation in April was 0.8% only to fall even further to 0.6 last month.

The United States economy continues to post mixed data. Friday’s PPI and Consumer Confidence were lower that combined with low retail sales and a pessimistic jobless claims. This week US Manufacturing came in above the forecast and even the revisions to April’s numbers were better than expected.

The Federal Reserve will hold its Federal Open Market Committee on Wednesday. There are no changes expected to interest rates and there is a small possibility of an increase in the tapering pace. The US employment situation does not warrant faster taper, but given how the Bank of England has stepped up their own time table it would not be a total surprise if the Fed adjusts to the expectations of higher rates early next year. Ironically the Fed might not need to reduce the amount of funds it designates to buying bonds given that in that now famous Janet Yellen inaugural press conference as Fed Chair. During her first question and answer period Yellen said that the Fed would start hiking six months after the end of the taper. At the current pace the end would be in the Fall of 2014 with an expectation of a rate hike in Spring 2015. This now seems to the be timetable that the BoE under governor Carney seem to have set for the UK economy.

IMF Trims US Growth Forecast. Employment Still Weak.

The International Monetary Fund has cut its forecast for the US economy by 0.8% in 2014, but maintains its 3% growth forecast for 2015. The IMF recommends the US stick to lower rates for longer as the organization sees shaky unemployment recovery. The Fund is urging the US to stimulate the economy by investing in infrastructure and take the burden off the Federal Reserve whose intervention has had questionable results even as they are planning to end the quantitative easing program. Yellen and her team will have the final word this week and the market is not expecting the IMF warning to have much of an effect in the FOMC decision.

Bank of England David Miles MPC external member said in an interview that he would vote for a rate hike before his term ends in 11 months. The fact that he is a known dove raises the probability of Carney getting more than enough votes before Spring 2015 to raise UK rates. The British economy has caught many analysts offside. This includes the teams at the Bank of England and the IMF who offered a retraction after their missed call. Mark Carney has worked alongside the government to prepare the Old Lady to meet the demands of a modern economy. The new powers over mortgages awarded to the central bank address one of the biggest risk identified by several agencies: housing.

Gold and Oil stable but upward trend expected due to Iraq and Ukraine-Russia
The situation in Iraq continues to escalate. The US has not ruled out armed intervention and there are talks with estranged Iran to counter the ISIS threat. US Secretary of State John Kerry said, “I wouldn’t rule out anything that would be constructive.” Russia has followed through on the gas deadline and after its passing without an acceptable agreement it has ceased to provide energy to Ukraine. The weekend saw renewed fighting between the Ukraine military and Pro-Moskow rebels after a plane was attacked resulting in the deaths of 49 Ukrainian soldiers.

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