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Weekly Focus – US Outperformance

High yields for longer remains the key narrative driving financial markets. 10-year US treasury yields traded close to 5% weighing on equity markets and JPY, as the contrast to the low yield regime in Japan grows larger still. Strong US data benefitted USD and risk-off sentiment took a toll on cyclically sensitive currencies like SEK and NOK. Oil prices receded back below USD90 per barrel, but energy prices largely remain elevated as markets are volatile and sensitive not least to the development in the Middle East.

The ECB kept rates unchanged for the first time since June last year and guided that they are done with additional rate hikes. President Lagarde made an effort not to rock the boat in terms of market pricing, she succeeded well and gave indications that this was a stock taking meeting only. Earlier this week, ECB’s bank lending survey also highlighted that the transmission mechanism is working as banks’ credit standards continue to tighten and firms and households’ demand for loans has declined significantly.

PMI data indicates growth divergence between the euro area and the US. The euro area is likely in the midst of a technical recession, with composite PMI declining further to 46.5, significantly below consensus as the manufacturing recession accelerated further in October and the service sector also weakened more than expected. Germany is a key driver of the weak figures, however the much more extensive IFO survey does paint a less dire picture of the largest euro area economy and thus leaves a less downbeat impression. US PMI data was better than expected and the Q3 national accounts emphasised how solid the US economy really is, with annualised q/q GDP growth of 4.9%, primarily driven by very strong private consumption. Core PCE inflation was slightly below expectations, though, which drove US yields somewhat lower.

The Japanese data indicated, the economic recovery has lost some steam with composite PMI at 49.9, below the 50-threshold for the first time this year. Even so, we think the data supports another tweak of the yield curve control by the Bank of Japan (BoJ) this year, most likely at the meeting ending on Tuesday, with the most likely move as an increase in the de facto 10Y yield cap to 1.5%. The recent surge in global yields has also prompted the BoJ to intervene in JGB markets several times recently.

In the euro area, we expect a large decline in October headline inflation to 3.1% from 4.4% in September on the back of a large negative contribution from energy prices but also a continuation of the fading underlying price momentum we have seen in Q3. We expect, Eurostat’s first estimate of Q3 GDP growth will reveal a small decline in economic activity.

It will be a very busy week in the US with FOMC meeting and several key data releases. We expect the Fed to remain on hold in line with consensus and market expectations, and look for no further hikes at a later stage either. We expect nonfarm payrolls growth to cool back towards the pre-September trend at +180k, yet still continue illustrating solid labour market conditions. Policymakers will keep a close eye on the earnings growth as well as the Q3 employment cost index to gauge how underlying inflation risks are developing.

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Danske Bank
Danske Bankhttp://www.danskebank.com/danskeresearch
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