European Inflation: An Inflection Point?

This year’s late Easter may have contributed to an outsized gain in April’s CPI. However, there are signs that underlying inflation in the euro area is turning the corner.


The timing of Easter distorted the March and April inflation data. The March CPI was unduly weak due to this year’s late Easter. The stronger April CPI is partly a payback from last month’s weakness. With headline CPI rising 1.9% y/y, inflation is effectively at the ECB’s “close to but below 2%” target.

The ebbs and flows in headline inflation will be dictated by oil prices. According to the futures market, the annual rate of change in oil prices will moderate, which will lead to slower headline inflation in the latter half this year.

Looking beyond the monthly seasonal noise in the data and the swings in energy prices, there are signs that core inflation is bottoming as the broad disinflationary pressures in the economy are abating. Our CPI diffusion index, which measures the breadth of price movements and leads core inflation, has recovered from the depths of 2013/14. It currently stands at 64%, meaning that the majority of the CPI subcomponents are accelerating. If the eurozone economy continues to grow at an above-trend pace (as our models predict), the output gap will close further and underlying inflation will gradually drift higher.

Bottom Line: The ECB will need to keep dialing back the dovishness as the euro area economy grows above potential and underlying inflation starts to trend higher.

Global Profit Growth On The Upswing

Stronger global growth should continue to power an acceleration in corporate earnings over the remainder of the year.


Global earnings revision ratio has turned positive for the first time in six years, implying that analysts have been behind the curve in revising up profit projections. Our profit indicators remain constructive for the U.S., Eurozone and Japan. In fact, our model suggests that U.S. EPS growth has a very good shot at matching perpetually optimistic bottom-up estimates for 2017.

Admittedly, it is disconcerting that the rally in oil prices has faltered in recent days as investors worry that increased U.S. shale production will thwart OPEC’s plans to trim bloated inventories. Without trimming stockpiles to more normal levels, storage capacity remains too close to topping out, which raises the risk of another price collapse.

A breakdown in oil prices could spark a major correction in the broader equity market. However, our commodity strategists expect the OPEC/Russia production cuts to be extended when OPEC meets on May 25. Consequently, we expect WTI and Brent to trade on either side of $60/bbl by December, and to average $55/bbl to 2020.

Bottom Line: Stronger global growth will lead to stronger corporate earnings growth and underpin global equities. Weaker oil prices pose a downside risk, which we are monitoring.

Opposing Market Signals

Global equities are near their cyclical highs, but several safe-haven assets are rallying.


Three safe-haven assets have been undergoing a recovery since mid-December: gold, the Japanese yen and 10-year U.S. Treasuries. Gold has retraced all of its post-U.S. election decline. USD/JPY has given back about 62% of its rally following the election, while the10-year Treasury yield has retraced 50% of its advance. In relation to these trends, the equity market is the so-called “odd man out”.

BCA’s cyclical view of global risk assets remains bullish, but a variety of asset prices are indicating a subtle shift towards risk aversion. This could be due to geopolitical worries and/or a downgrading in growth expectations. Whatever the reason, a continuation of these trends could signal a broader retrenchment in global risk assets. We would view this as a long overdue technical setback from overbought levels. Any such correction would represent a buying opportunity on a 9-12 month cyclical investment horizon.

A Warning Sign For EM Equities

A relapse in industrial metals versus lumber prices is a poor omen for EM equities.


The ratio of industrial metals to U.S. lumber prices has had a reasonably good track record in gauging relative performance of EM versus U.S. share prices. Industrial metals prices are a proxy for economic growth in China/EM, while U.S. lumber prices are indicative of America’s business cycle. Industrial metals prices (the LMEX index) have lately underperformed U.S. lumber prices, pointing to renewed EM underperformance versus the S&P 500.