L'emploi frappe les hausses

• The “dovish nuggets” in the Fed and the ECB’s communication last week were sparser than what the market reaction would suggest. The US payroll – rightly - put a dampener on the market enthusiasm.
• We are concerned by the steep decline of the “credit impulse” in the Euro area – but the ECB may believe wage bargaining will be slow to react to a deterioration in economic conditions.

For the “dovish pivot” to be imminent, two conditions need to be fulfilled. First, communication from the central banks need to change. Second, the dataflow needs to be consistent with inflation landing within an acceptable timeframe. There were some tentative alterations to the Fed and the ECB’s messages last week, even if we think they should not be overstated. In the Q&A, Jay Powell may have been too vague in the rebuttal of the market still pricing cuts. The ECB has acknowledged that the balance of risks around their inflation baseline scenario is now “more balanced”. But the market’s enthusiasm in seizing on these dovish nuggets crashed against the strong US labour market data coming out on Friday.

Christine Lagarde’s slight communication downshift was in our view heralding more a mere slowdown in the pace of hikes to 25 basis points after March than a pause, and we continue to think the risk to our unchanged central scenario – that the ECB stops after hiking to 3.25% in May – is subject to an upside, rather than a downside risk. While we think the market is too confident now on growth prospects in the Euro area – we are concerned by the steep decline of the “credit impulse” in deeply negative territory – we also believe the ECB is worried about the impact of some of the institutional characteristics of the European labour market in 2023: centralized wage bargaining systems can result in a delayed response of wage dynamics to a deterioration in economic activity, as past inflation plays a bigger role than in decentralized system, such as the one which prevails in the US.

In a nutshell, while in the US the issue is that the monetary tightening has not bitten enough yet to tame the labour market, in Europe it may be that the monetary is starting to work its way through the economy, but with only slow impact on underlying inflationary pressure. We would not bet on the patience of policymakers, however “less hawkish” they have sounded recently.