Japanese GDP contracted in Q3 of this year, but less than feared

Markets

Friday’s fresh sell-off in the UK gilt market served as a chill reminder that deteriorating public finances are here to stay as a market theme. Not only in the UK, but globally. The UK yield curve bear steepened with yields rising by 8.2 bps (2-yr) to 16.4 bps (30-yr). Sterling eventually managed to erase intraday losses, closing almost unchanged at EUR/GBP 0.8822 after briefly moving above 0.8850 for the first time since April 2023. The government’s U-turn on raising income taxes in next year’s Budget (Nov 26 release) set things in motion. The positive connotation to not having to raise taxes again and break the election manifesto (after gently preparing for that hard message for over a month) paled compared with the feeling that Labour lost control over the fiscal narrative. The lack of visibility for UK households and firms and the lack of vision from the ruling party increases uncertainty and questions the ability to get finances back on track. Markets whipsawed after Bloomberg reported that more favorable projections by the Office for Budget Responsibility triggered the government’s change of heart but that intraday rebound didn’t last for long. The OBR estimates the budget gap to be £20bn rather than the long-feared £35bn (without restoring existing fiscal buffers). Chancellor Reeves later said that she won’t lower the thresholds at which people pay the basic and higher rate of the income tax but rathe extend the freeze at current levels. Markets considered this as kicking the can down the road and now expect a mixed bag of small, non-structural, measures to plug the budget hole. The political episode highlights the fragility of the Starmer-Reeves leadership with internal revolt building.

European and US markets followed the bear steepening signal. EUR swap rates ended 1 bp (2-yr) to 3.1 bps (30-yr) higher. From a technical point of view, the 2-yr swap rate closed at its highest level since the end of March (2.19%) with money markets no longer erring on the side of an additional ECB rate cut. The 10-yr swap rate (2.75%) had only one higher close since July 2024. The 30-yr swap rate (3.04%) extended its push beyond 3% to reach the highest level since November 2023. The US yield curve closed 1.6 bps (2-yr) to 3.6 bps (30-yr) higher. The risk correction came to a halt on Friday as bottom fishers showed up, helping main US equities to close unchanged (S&P 500) to slightly higher (Nasdaq) after incurring opening losses of almost 2%. EUR/USD is still going nowhere just north of 1.16. Today’s economic calendar only contains the US Empire Manufacturing Survey and EC forecasts. We don’t expect them to set the tone for global trading. We keep a close eye at interest rate markets to see if last week’s bear steepening moves get more traction.

News and views

The central bank of Spain is projecting a budget deficit of 2.3% for 2026, down from 2.5% this year. That would mean a lower shortfall than Germany’s expected 3.1% for the first time in almost 20 years in what is another sign of how intra-EMU fiscal fortunes have significantly changed over the last couple of years. The (semi-)core struggles to rein in outsized deficits (eg. France, Belgium) or simply opens the taps (eg. Germany) while the periphery is taking a grip on public finances. For Spain in particular its fast-growing economy has been a boon. GDP since 2022 expanded at an average clip of +/- 4% y/y compared to less than 0.5% for Germany. It allowed the government to pencil in a primary surplus for this year, its first since 2007.

Japanese GDP contracted in Q3 of this year, but less than feared. The economy shrank by 0.4% Q/Q or 1.8% in yearly terms, compared to the -0.6% and -2.4% expected. The Q2 print in addition saw a slight upward revision to 0.6% and 2.3% respectively. The GDP decline came on the back of a sharp drop in residential investment, fixed capital formation and net exports which anemic private (accounting for around half of the economy) and government consumption was unable to offset. The Japanese yen barely budged on the release with USD/JPY treading water around 154.7. Yields, however, do rise, especially at the long end of the curve. This may be inspired by growing expectations for the promised big fiscal package by PM Takaichi to support the economy, to be announced over the summer. Japan’s 20-yr yield – in focus due to the upcoming auction on Wednesday – rises to a new multidecade high of 2.75%.

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