Disappointing US Q4 GDP growth?

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Disappointing US Q4 GDP growth?

Global markets were adrift yesterday, lacking any consistency. The intraday bias for core bonds was slightly downwardly oriented with an underperformance of US Treasuries. Support levels in Germany/US (10yr & 30yr yields) were tested but held and triggered a technical rebound. Eco data were merely a footnote in trading, though we retain that German inflation turned negative. At the end of the day, changes on the German yield curve were limited between -0.9 bps (2-yr) and +0.8 bps (30-yr). The US curve bear flattened with yields 5 bps (2-yr, including benchmark change) to 2.4 bps (30- yr) higher. On intra-EMU bond markets, 10-yr yield spreads versus Germany widened up to 3 bps with Greece outperforming (-18 bps).

The eco calendar remains well-filled today with January EMU inflation data, EMU unemployment rate, first estimate of US Q4 GDP, Belgian and Spanish Q4 GDP, US Chicago PMI and the final reading of Michigan consumer confidence.

January EMU inflation is forecast to fall deeper into negative territory. The consensus is looking for a drop from -0.2% Y/Y to -0.5% Y/Y, mainly due to lower oil prices. Core inflation, on the contrary, is expected to remain stable at 0.7% Y/Y. Besides energy, also prices of clothing and footwear probably dropped due to the sales period, while also prices of leisure & entertainment are expected lower as Christmas holidays ended. Yesterday, German inflation data came out significantly lower than expected and therefore we see downside risks for the EMU reading too. For the core measure, we have no reasons to distance ourselves from the consensus. The EMU unemployment rate is forecast to stay unchanged at 11.5% in December, which if confirmed would be the fifth consecutive month. The labour market recovery stalled over the previous six months and we expect no change in December. Therefore we have no reasons to distance ourselves from the consensus. In the US, the focus will be on the GDP data. After a very strong Q3, growth is forecast to have slowed during Q4. The consensus is looking for a growth figure of 3.0% Q/Q annualized, down from 5.0% Q/Q annualized in the previous quarter. We believe that the risks are for a weaker outcome. Although personal consumption probably remained on track, we expect that non-residential investments will act as a drag on growth together with government consumption. The contribution from net exports should be relatively small too as well as residential investments. The Chicago PMI is expected to have weakened slightly further, while Michigan consumer confidence is forecast to stay unchanged at its multi-year high of 98.2. These should however have no major impact on markets.

In the US, the Treasury held a solid $35B 5-yr Note auction and an average $29B 7-yr Note auction. The 5-yr Note auction stopped below the 1:00 PM bid side with the bid cover a touch light relative to the average (2.49 vs 2.72). Bidding details showed that strength was led by the indirect bid, i.e. foreign investor demand. That shouldn’t surprise given the relatively “high” US yields. The 7-yr Note auction stopped with a moderate tail and the bid cover was slightly below average (2.50 vs 2.56). Buyside demand was solid with again a strong indirect bid.

Overnight, Asian stocks trade mixed. They opened strong on the back of WS’s rebound (solid earnings) but sentiment deteriorated throughout the session. Japan outperforms slightly while eco data were mixed. The US Note future has an upward bias, suggesting a firm opening for the Bund.

Today the eco calendar is well-filled. With ECB QE yet to start, the impact of EMU eco data in general diminishes even though EMU CPI is set to drop further in negative territory. US eco data are interesting with especially the US Q4 GDP reading. We see risks on the downside of expectations. This could reinforce positioning on US rate markets (lift US Treasuries), which discount that the Fed will delay a first rate hike beyond the Summer.
Sentiment on equity markets remains a driver for core bonds as well though the correlation between the two diminished of late. Greece is a wildcard with the new Syriza-led coalition on collision course with Europe (e.g. delay additional EU sanctions against Russia; core bond positive). Eurogroup Dijsselbloem meets with Greek PM Tsipras and FM Varoufakis later today. Greek assets are expected to continue to underperform with small contagion to other peripherals the past days. Technically, both the German (0.35%) and US (1.70%) 10-yr yields bounced off the cycle lows which could limit short term upward potential for bonds. In a day-to-day perspective, sentiment remains bullish for bonds.

Longer term, once the ECB QE-programme begins, flows will play a very important role and will likely act as a key constraining influence on upward potential of most EMU bond yields. In the US, the FOMC meeting made clear that the Fed remains on path for a first rate hike this Summer (see higher). For now, rate markets don’t buy it. We wouldn’t preposition yet (short US Note future), but look closely for a turning point. Bund: Greece