10-Year Yields: Eight Eurozone Members Just Saw Record Lows

The US dollar's gains scored yesterday are being consolidated now, giving it a somewhat heavier tone. Equity markets are mixed, consolidating this week's gains. Bond markets are also mostly quiet.

There are a couple of exceptions. Sweden reported Q4 GDP of 1.1% quarter-over-quarter, which is twice the consensus expectation. The Q3 growth of 0.3% was revised higher to 0.5%. The positive momentum spilled over to the January retail sales report, where sales jumped 1.2% fully recouping December's 0.6% decline.

The lowflation, and now outright deflation (January CPI -0.2% year-over-year) has not hobbled the economy. And that is what the retail sales figures mean— that Swedish consumers are not hunkering down anticipating lower prices in the future. On the other hand, it is the deflationary conditions that prompted the Riksbank to adopt negative deposit rates and initiate a small bond buying program. Today's data suggests that Riksbank will not be in a hurry to extend current accommodative efforts.

The krona is the strongest currency today with a 0.8% rise against the dollar. This is sufficient to turn higher on the week against the US dollar, which is up against most currencies. The krona has gained nearly 2% against the euro this week. The euro had tested the SEK 9.70 level toward the middle of the month and is now finishing around SEK 9.36, close to where it began the month. A trendline connecting last October and the January lows comes in near SEK 9.32 today.

While core bonds have a heavier bias today, the peripheral bonds have continued to rally and benchmark yields are at record lows. Eight eurozone members saw record low 10-year yields yesterday and today" Germany, Netherlands, Austria, France, Italy,Finland, Portugal and Ireland. Germany sold 5-Year and 7-Year bonds this week with negative yields. This week Italy and Portugal sold new bonds at record low yields. The spread compression continues as well. The Spanish premium, for example, over Germany on 10-year yields has fallen below one percent this week (now 92 bp on the benchmarks) for the first time since 2010. Italy's premium is also slipping through one percent today.

The market is clearly anticipating the start of the sovereign bond buying program that will be launched next month. Still, on the day that the German parliament is debating the new four-month extension of Greece aid, and considering the costs, shouldn't the debt servicing savings be understood as offsetting some of the costs? Indeed the direct costs are quite modest, while the indirect costs (like loan guarantees) are considerably higher, but do not requite cash out of the pocket.

The Italian and Spanish bond rallies are all the more impressive today given that both reported stronger than expected preliminary CPI figures for January. Using the harmonized methodology, Italy reported a 0.3% increase on the month, which was sufficient to lift the year-over-year rate back into positive territory, though just barely. The 0.1% rise contrasts with the consensus forecast of a 0.3% decline. It was -0.5% in December.

Spanish CPI was expected to be unchanged at -1.5%, but instead it slipped to -1.1%. It is, of course, still experiencing deflation, but less so. Separately, German states are reporting their February inflation figures and each is showing higher inflation (really inflation instead of deflation).

Ironically, this is the context for the start of the ECB's asset purchases. Money supply is accelerating. The two-year contraction in bank lending is ending. The economies, say for France (and now Greece) are seeing better growth numbers, though not great. The combination of the euro's depreciation, lower interest rates, and lower oil prices over time will be supportive. However, part of the euro's depreciation and decline in bond yields reflects anticipation of the asset purchases.

Outside of a strong industrial production report (4.0% in January vs. 2.7% consensus), Japan reported a series of disappointing data. The unemployment rate unexpectedly ticked up to 3.6% from 3.4% and retail sales fell 1.3% in January, a three times larger decline than expected. Overall household spending slumped 5.1% from a year ago. The consensus expected a 4.1% decline after -3.4% in December.

However, the most disappointing for the BOJ was the softer core inflation figures. Japan's core measure, which excludes fresh food, slipped to 2.2% from 2.5%. The BOJ adjusts for last April's sales tax increase, which means inflation is running close to 0.2%, compared with the 2% target. Many in the market think this means pressure will build on the BOJ to ease policy further. We suspect the BOJ will wait for the spring wage round before deciding on whether to do more. Expanding the balance sheet by 1.4% (of GDP) a month has not been sufficient given the other forces at work, like the decline in energy prices, to put Japan on a clearly inflationary path. Even when food and energy are excluded, Japan's CPI is barely over zero.

The US reports revisions to Q4 GDP. The risk is that the 2.6% pace is revised to a little below 2%, due to subsequent inventory and trade data. Yellen was well aware of this risk before this week's testimony. It did not change her overall assessment of the economy. Moreover, we suspect the Fed is more impressed with the 4.3% rise in personal consumption than the overall softer GDP. In addition, after two quarters of overall growth averaging more than four percent a return towards trend growth is not problematic.

Separately, the inflation expectations component of the University of Michigan's consumer confidence report may draw increased attention given the Fed's efforts to play down market-based measures of inflation expectations. Lastly, the US oil rig count continues to be watched even though output is continuing to rise.