In focus today

Today, the European Commission will release its spring economic forecast, likely revising euro area growth expectations from November's 1.3% y/y to align with private banks' consensus expectations of 0.8% y/y and the ECB's 0.9% y/y projection from March. Attention will also be on the German fiscal package's inflationary impact, viewed by some ECB members as a potential medium-term price pressure risk. We will also receive euro area final inflation for April, set to clarify the drivers of unexpectedly high core services inflation. Final data from Germany showed that it was largely attributed to the timing of Easter, affecting package holidays and airfares, indicating a one-off increase rather than a resurgence.

Overnight, China's central bank is set to announce the 1-year and 5-year Loan Prime Rates of Chinese banks. They are expected to drop by 10bp to 3.0% and 3.5% respectively, following the reverse repo rate cut by 10bp on 6 May. This should thus be seen as a mechanical transmission rather than new easing.

Early tomorrow, the Reserve Bank of Australia (RBA) is expected to deliver its second 25bp rate cut of the cycle, with markets pricing around a 90% probability. The RBA will likely keep its forward guidance cautious, avoiding pre-committing to further easing.

Economic and market news

What happened overnight

China's economic data for April sent mixed signals. Retail sales growth fell short of expectations, increasing by 5.1% y/y (cons: 5.5%, prior: 5.9%). In contrast, industrial production surpassed expectations with growth of 6.1% y/y (cons: 5.5%, prior: 7.7%). Home prices remained steady, experiencing a 4% y/y decline, underscoring the ongoing vulnerability in the housing market. This data precedes the trade agreement between the US and China reached on 11-12 May, so it can be regarded as 'old news'.

What happened over the weekend

In the US, consumer sentiment dopped to nearly a three-year low in May, accompanied by rising inflation expectations, with one-year expectations reaching their highest level since 1981 and five-year expectations rising to 4.6% (prior: 4.4%). Notably, the survey period began on 22 April, preceding recent optimism about a US-China deal (survey ended last Tuesday).

On Friday, Moody's downgraded the US sovereign credit rating to "Aa1" due to concerns over the nation's, growing, USD 36trn debt pile. This move underscores the grim US fiscal outlook and highlights the absence of political willingness in Washington to tackle the issue.

In Romania, centrist Nicușor Dan secured the presidency, garnering 54% of the vote and defeating nationalist contender George Simion. Dan's victory is perceived as a reaffirmation of Romania's commitment to EU and Nato alignment, easing concerns of nationalist shifts. His win is expected to enhance investor confidence, backed by promises of anti-corruption reforms and economic stability.

In Poland, liberal candidate Rafał Trzaskowski narrowly won the first round of the presidential election with 30.8% of the vote, edging out right-wing opponent Karol Nawrocki, who secured 29.1%. The upcoming runoff on 1 June is crucial for Prime Minister Tusk's pro-EU agenda, as the presidency holds veto power over legislation matters.

Equities: Equity markets extended their positive momentum on Friday, closing the week with five consecutive days of gains. We saw notable outperformance from cyclicals throughout the week, although that narrative slightly reversed on Thursday and Friday, with defensive sectors catching up into the weekend. It was more a case of defensives closing the gap than cyclicals selling off meaningfully. As a result, we are now just a few percentage points from all-time highs in equities and around 5% above the level we saw prior to 'Liberation Day' on 2 April. In this "risk-on" environment, implied volatility has dropped further - the VIX is now at 17. Cross-asset correlations last week continued their move back toward normalised or historical "standards". Frankly, we are a bit surprised at how rapidly markets - across assets - have recovered to pre-'Liberation Day' levels. However, this morning we are seeing a clear reversal: equities are trading lower across Asia, and futures are pointing lower in both Europe and the US. Notably, tech futures are taking the largest hit today. But equity moves do not live in a vacuum - we are also seeing a sharp rise in US Treasury yields and a weaker dollar. The moves are being driven by a combination of budget gridlock in the US and Moody's credit rating downgrade of the US.

FI&FX: Late on Friday, Moody's downgraded the US credit rating from Aaa (neg. outlook) to Aa1 (stable). The credit agency motivated its decision by a worsening public debt outlook and the Republican plans to extend the TCJA tax cuts. 10y USTs now trade above 4.50% and is some 6-7bp higher than before the announcement. Overall, we believe that the market impact should be limited, but the downgrade serves as further evidence of the dire US fiscal outlook and the lack of political willingness in Washington to address it. The dollar has also weakened somewhat on the announcement with EURUSD moving from 1.1150 before the announcement to around 1.1185. The risk-off sentiment overnight has also supported USDJPY reaching a low of 144.81 but it has since stabilised around 145.25.