German bonds rallied hard again yesterday, as the Fed’s message was shrugged off and the focus was on continued downward surprises in inflation (see more below). The German 10-year yield plunged by 5bp to 0.84%, but remains more than 10bp above the record-lows reached earlier in the month. In the US, the fall in yields was more moderate, and there the 10-year yield ended the day down by only around a bp.
Intra-Euro-area spreads mostly widened, implying increasing ECB expectations were not the main driver. Especially Spanish bonds felt pressure, and the 10-year spread vs Germany jumped by around 7bp, as Prime Minister Rajoy said his government would consider filing another lawsuit against Catalonia over their plans for an informal consultation on independence on 9 November. The Catalan question will continue to cast a shadow over Spain for now.
European equities recovered from early weakness, and the Stoxx 600 finally ended the day up by 0.59%. In the US, S&P 500 gained 0.62%. Asian equities have surged overnight following more easing from the BoJ (see more below), and e.g. the Japanese TOPIX is up by around 4.5% at the time of writing. USD/JPY, in turn, has surged to its highest since early 2008. Also European equities are set to open clearly higher.
Core bond yields are set to rise today and the curve steepen on the back of better risk appetite. True, month-end flows and soft inflation data should continue to support bonds, but expectations for Euro-area inflation are likely quite low already after yesterday’s data.
BoJ expands its easing measures
The Bank of Japan surprised by announcing an expansion to its stimulus efforts, though after heavy debates and a very close vote of 5-4. The bank decided to accelerate the annual pace of increase in the monetary base to 80 trillion yen, an increase of 10-20 trillion compared to the past. The average maturity of the government bond purchases will be extended to about 7-10 years, an extension of some three years, while the purchases of exchange-traded funds and Japan real estate investment trusts will be tripled. In other words, the BoJ will provide increased direct support also for the equity market. The new measures were a response to the weak demand developments following the consumption tax hike and the further downward price pressures coming from lower oil prices, which risk contributing to a deflationary mindset.
The new measures are an illustration that the BoJ means business, and after the recent setback, help build confidence that it remains committed to reaching its inflation target. In the wider context, the steps are a further reminder that in the current environment, many central banks will continue to move into ever larger stimulus measures, even if the Fed is now done with its QE programme.
Strong growth continued in the US
US Q3 GDP numbers beat expectations with 3.5% annualized growth, following 4.6% in Q2 and the fourth quarter in the past five that saw 3%+ growth. However, not all the details were as positive. True, final demand (GDP less changes inventories) expanded by an even stronger 4.2% annualized, but real domestic final demand (GDP less net exports and changes in inventories) rose 2.7%, down from 3.4% in Q2. Personal consumption growth, in turn, slowed from 2.5% to 1.9%.
Also inflation pressures continued to be tame, with the core PCE rising at an annualized pace of 1.4%, a fall from the 2.0% rate seen in the previous quarter. In conclusion, the Q3 GDP reports adds to evidence that the US economy is doing rather well, and the Fed really can move closer to monetary policy tightening, but the still modest inflation pressures mean the central bank is not yet in a hurry.
Euro-area sentiment surprisingly rebounds – Spanish economy still doing well
The Euro-area economic sentiment indicator supported hopes of stabilizing confidence. The indicator rebounded from 99.9 to 100.7, back above its long-run average and following two months of declines. The German indicator rebounded from 103.8 to 104.4, relieving some fears after the disappointing Ifo, and gains were seen in all the largest Euro-area economies except Spain. At its current level, the indicator is pointing to around 1.5% GDP growth for the Euro area, and does not support fears of another recession.
In Spain, Q3 GDP was reported to have expanded by 0.5% q/q in the third quarter, somewhat lower than the 0.6% recorded in Q2 but very respectable relative to the Euro area in general. The number was in line with the earlier estimate from Bank of Spain.
Ouch – another downward surprise in inflation
The ECB just does not seem to catch a break as far as inflation is concerned. Preliminary October numbers for Germany surprised to the downside, with the EU harmonized measure edging down from 0.8% y/y to 0.7% against expectations of a rise. This left the German inflation at a 5-month low, and suggested downward surprises in inflation are not behind. Pressure for the ECB to do more is thus in the increase again.
Busy calendar: no rebound in Euro-area inflation?
Draghi must be watching today’s inflation numbers with great anxiety especially after yesterday’s soft German numbers. From a market perspective, expectations fell already after yesterday’s data, and thus the market reaction would likely be larger in case of an upward surprise. The flash estimate of Euro-area October inflation will be released at 11:00 CET.
In the US, the Q3 employment cost index at 13:30 CET will be followed very carefully after the jump seen in Q2, and another high number would quickly add pressure on bonds. The September personal spending report will be out at 13:30 CET, the Chicago PMI at 14:45 CET and the final October University of Michigan consumer confidence at 14:55 CET.
In addition, the Fed’s Williams will speak at 8:00 CET, the ECB’s Linde at 9:00 CET and Visco at 17:00 CET. The monetary policy decision by the Russian central bank at 11:30 CET will also gather interest.
In the ratings calendar, Moody’s has a chance to review its Aaa rating on the Netherlands.
Nordea