US GDP contracts for the first time in three years

In focus today

• Today is a quieter day in terms of releases due to International Workers' Day, which is a public holiday in many European countries.
• In the US, the April ISM Manufacturing index is due for release in the afternoon. The regional Fed manufacturing surveys are pointing towards a clear decline as earlier front-loading of orders appears to have slowed down when the sharp tariff hikes were announced in early April.

Economic and market news

What happened overnight

In Japan, the Bank of Japan (BoJ) kept rates unchanged this morning as widely expected. At the same time, the central bank cut the outlook for growth by 0.6pp in the fiscal year (FY)2025 and 0.3pp in FY2026, blaming the trade war. Also, inflation forecasts have been cut by 0.2pp to 2.2% for FY2025 and 0.3pp for FY2026 to 1.7%. The new FY2027 forecast is 1.9%.

The policy statement is extremely short and there is no mention that the BoJ still expects to hike rates further down the road. That is perhaps also why USD/JPY traded quite a bit higher from 143.1 to 143.7 levels and JGB yields traded lower on the back of the decision. The BoJ needs to walk a fine line these days, postponing further rate hikes because of the trade war uncertainty but still sounding hawkish enough to not weaken the yen too much, which is not desirable during trade negotiations with the US. We will witness this balancing act at the press conference this morning.

With solid wage growth this year, reflating the economy is on track and thus we still believe the BoJ is ready to hike rates further. We expect the next hike in the fall with the timing of course largely depending on the outcome of the trade war.

What happened yesterday

In the US, GDP contracted 0.3% (forecast -0.1%, cons. +0.3%, Q4 +2.4%), which was fairly close to our expectations. Looking at the details, private consumption growth in services and non-durable goods held up well, while durable goods consumption declined. Net exports contributed negatively by 4.8pp due to import front-loading, with around half of this offset by rising inventories. Overall, while the headline growth number was negative, the underlying growth trend remained relatively solid. Quarterly PCE inflation and Employment Cost Index surprised to the upside, causing rates to tick slightly higher. The quarterly figures suggest that core services inflation momentum picked up towards the end of the quarter, which could be seen as modestly hawkish signal.

Also in the US, the ADP private sector employment report for April came in well below market expectations at 62k (cons: 115k, prior 155k). It was the softest increase since July of last year, highlighting the impact of tariffs by the US government on businesses' hiring of new labour, and giving the markets a first sense of what to expect from Friday's April Jobs Report.

In the euro area, GDP grew 0.4% q/q in Q1 2025, beating expectations of 0.2% q/q growth. The print was a "low" 0.4% as growth was 0.35% q/q, but it still shows that the euro area economy had a good start to the year by European growth standards. The first aggregate print does not provide details on the growth drivers, but country data shows that growth in the first quarter was once again held up by Spain, which rose 0.6% q/q, while France was weak at 0.1% q/q, Italy grew 0.3% q/q, and Germany activity rose 0.2% q/q.

Also in the euro area, French CPI inflation remained at 0.8% y/y in April, slightly above expectations of a decline to 0.7% y/y from 0.8% y/y in March. Energy inflation pulled inflation down, while core services and goods inflation were unchanged. In Germany, CPI inflation came in slightly higher than expected, in line with signals from regional data. The German CPI index declined to 2.1% y/y in April from 2.2% y/y in March, above expectations of a fall to 2.0% y/y. The decline was due to energy, food, and goods inflation. Overall, with data from France, Spain, and Germany data out, euro area inflation (out on Friday) is heading for a slightly higher reading in April than expected. 

Equities: Equities rose yesterday, notably after a sharp intraday rebound, particularly towards the close of US cash trading. While the day ended with only modest gains, the scale and timing of the recovery was remarkable. Early in the session, equities were under pressure, partly due to unfavourable macroeconomic data, but political narratives remained the dominant driver throughout the day.

It is noteworthy that markets have now clawed back to levels seen before "Liberation Day" - prior to 2 April, when Trump reignited tariff rhetoric with aggressive reciprocal proposals. Since then, trade tensions between the US and China have escalated significantly. Meanwhile, bond markets - both at the front and long ends - have retraced, with short-term yields now sitting even lower than pre-Liberation Day levels. Similarly, implied volatilities in both equities (VIX) and rates (MOVE) have compressed back to those early-April levels.

One could rightly ask whether the world now looks better - or even remotely as good - as it did on 1 or 2 April. Objectively, that seems doubtful. Economists have aggressively slashed growth forecasts, earnings revisions have turned sharply negative, and despite the postponement of the reciprocal tariffs, US-China trade is operating at tariff levels effectively incompatible with meaningful exchange. In the US yesterday, Dow +0.4%, S&P 500 +0.2%, Nasdaq -0.1% and Russell 2000 -0.6%. This morning, Asian equity markets are mixed, but with a modest positive bias. The bigger story is in US equity futures, especially in tech, where strong aftermarket earnings yesterday have propelled futures higher.

FI & FX: The UST curve steepened modestly yesterday, led by front-end outperformance. The 2Y yield declined 6bp, while the 10Y fell 2bp and the 30Y rose 2bp, reflecting a front-led rally and some upward pressure further out the curve. The transatlantic spread narrowed slightly, as German Bunds outperformed across the curve. The 2Y Bund yield fell 6bp, while the 10Y declined 5bp, resulting in a mild bull steepening of the German curve. EUR/USD remains confined within the 1.13-1.14 range, as has been the case for most of the second half of April. Yesterday's economic data had little impact on the cross, and for now, the broader FX market appears relatively unresponsive to incoming releases. USD/JPY is trading nearly one figure higher this morning following the BoJ's widely expected decision to hold policy steady. With downward revisions to both growth and inflation forecasts, the overall message from the BoJ was dovish.