European data added to the hawks arguments

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European equity markets are sold out across the board, as global equity markets came under pressure from rising yields and heightened expectations, hitting technology stocks in particular. In this environment, strong data releases only add pressure rather than lift sentiment on stocks and the GER30 and UK100 are currently down -1.2% and -0.8% respectively.

Core EGBs were little changed, with the 10-year Bund yield falling -0.4 basis points to -0.033% after the paper erased earlier losses. the German 10-year-old clearly preparing to break negative territory for first time since early 2019, but not quite as far as it seems. the The 10-year Treasury rate is now unchanged at 1.18%, while peripheral euro-zone yields rose 2.5 basis points to currently 1.809% on the day on the back of a 2.5 basis point hike in US 10-year rates. Confidence in recovery is strengthened, but that also boosts expectations. the BoJ revised its inflation outlook today for the first time in a long time and the BoJ’s Kuroda was clearly intent on preventing markets from running away with falling expectations.

But that wasn’t enough to reassure broader markets, especially as European data today reinforced the arguments of BoE and ECB hawks. UK jobs data looked surprisingly strong with December employment picking up despite the rise of Omicron. The confidence of German ZEW investors rose to the highest level since July last year, despite a still difficult virus situation in Germany.

Against this background, the ECB in particular will find it difficult to keep tightening expectations in check.

the German economy rose 2.7% over the past year, after a -4.6% decline in 2020 (or -4.9% on a calendar-adjusted basis). The statistics office reported that the manufacturing sector grew by 4.4% and that the services sector also improved, although the trade and hospitality sectors continue to struggle with the impact of the virus restrictions. Only the construction sector, which was not too badly affected by the pandemic in 2020, contracted by -0.4%.

Most sectors have not yet reached pre-crisis levels and public consumption has been the main driver of overall growth. Private consumption stagnated after shrinking by -5.9% in 2020. Exports recovered by 9.4% in 2021 and imports by 8.6%, roughly matching the contraction of the previous year.

The labor market remained robust and the number of employees subject to social security contributions has actually increased. GDP per person employed increased by 2.7% after falling -3.8% in 2020. Overall a report that is pretty much in line with expectations and while last year’s recovery has not been in line with expectations for France, Spain and Italy, the contraction in Germany in 2020 has not been as pronounced as elsewhere either.

Looking ahead, Confidence of German ZEW investors rose much higher than expected to start the year – with a headline reading of 51.7 in January – and higher than the previous month’s 29.9.

The indicator of current conditions was still falling, but the headline jump left the confidence reading at its highest level since July 2021, suggesting investors have already shrugged off Omicron and expect the global economy to recover quickly.

The data will keep the ECB in a defensive mode as officials will struggle to prevent inflation expectations from picking up while trying to keep tightening expectations in check.

The official line remains that a rate hike is very unlikely this year, and given that the starting points for the Fed and ECB were very different when Covid-19 hit, the extent of the monetary policy correction the ECB may be making this year is unclear year plans, already pretty much in line with the Fed’s efforts.

Still, the fact that the central bank continued to add net asset purchases for most of the year means there is now a risk of a more permanent inflation overshoot, which could undermine confidence in the central bank’s anti-inflation credentials.

EUR USD failed to benefit from excellent ZEW report and EUR is trading well below the 1.14 level. With ZEW largely reflecting optimism that the US economy will recover quickly and looking ahead as fundamentals in the form of faster growth, widening interest rate differentials and an aggressive Fed all point to a higher US dollar, EURUSD is likely to continue falling in the coming weeks.

Interest rate differentials and the Fed’s much more hawkish stance continue to limit upside. The Bund yield has come a long way but may need stronger support from the ECB to exit negative territory.