Sometimes the news stream drives prices, and sometimes the price action drives the narratives.  We argued that the sharp decline in equities at the start of the year was fanned the doom and gloom in the media and market commentary.Many had been taking about a new financial crisis and parallels were drawn between the price action now and the 2007-2008 period.

Perhaps it was the green shoot of spring flowers in the Northern Hemisphere.  Perhaps it was the realization that the sell-off was exaggerated. Perhaps it was return of share buybacks following the earnings season. In any event, an important inflection point was reached February 10-12. Since then risk appetites have recovered.

As we argued, fears that the US was falling into a recession were greatly exaggerated.  After slowing to a revised annualized pace of 1% in Q4 2015, the US economy is returning to trend growth. Incorporating the employment and trade figures released at the end of last week, the Atlanta Fed says the economy is tracking 2.1% growth in Q1.

Without relying on revolving credit to finance consumption, households are forced to rely more on current income.The continued improvement of the labor market is critical. The fall in average hourly earnings in February was disappointing, but we are persuaded that it reflects a quirk in when the survey is taken relative to when bimonthly paychecks are received. If this is correct, then consumption may hold up better than the earnings data may suggest. The quirk may be repeated this month, but come the spring, as the June FOMC meeting comes into view, the earnings data should snap back.

The increase in risk appetites has taken place alongside a reassessment of Fed policy.  This is reflected in the 13 bp increase in the implied yield of the June Fed Funds futures contract over the past three weeks.At 45.5 bp, the June contract implies almost a 2/3 chance of a hike at the mid-year meeting.  Offsetting perceived increase in the chance the Fed is not one and done that so many had thought is the increased confidence that China, the Eurozone, and Japan will be providing additional support.China has cut required reserve ratios, which frees up the equivalent of over $100 bln.

The ECB meeting is the center of attention next week.  A combination of renewed deflation (-0.2% year-over-year February CPI and 0.7% core rate), weakening economic data, and guidance by Draghi has fanned expectations that the ECB will extend its unorthodox policies.The market is cautious after being disappointed with a 10 bp rate cut and extending the asset purchase program by six months (~360 bln euros of purchases).

There are two main questions.What will the ECB do and what will be the economic and financial impact?The market seems to feel most confident that the deposit rate will be cut by at 10 bp, and a tiered system that will ease some of cost to banks, which for the most part is not being passed on to retail accounts.The derivatives markets indicate there are some expecting 15-20 bp cut. 

However, if this is all the ECB does, investors will likely be disappointed. To get ahead of the curve of expectation, the ECB must do more.The purchase program can be extended for another six months.The end date is soft in any event, and the cost, of suspending it altogether, is that it denies a signaling channel.Increasing month purchases from 60 bln euros might have the biggest impact on market sentiment.  This would raise new questions about the sustainability (e.g., are there sufficient German securities?).