Overnight Sentiment: Zen-like After Initial Revulsion

Futures are unchanged after dropping steeply overnight following the Spanish re-downgrade as the Italian 5/10 year bond auction was bad, but still passed (somehow the lack of the European bond market ending is good news). This is ironic with Europe very much on edge following the release of very disappointing EU data, with German confidence, French consumer spending, Spanish unemployment all worse than estimates. Offsetting all of the negativity to some extent is the gross JPY10 trillion and net JPY5 trillion injection by the BOJ, which is a harbinger of what will happen west of Japan when push comes to shove. And so now all eyes turn to US GDP, which, continuing the Constanza bizarroness, better miss for stocks to surge, as a beat of consensus of 2.5% will mean the Chairman was not joking when he told the world he was morphing from a dove to a hawk (if only for theatrical purposes).

More on the overnight action from BofA:

Market action

Asian stocks finished lower after a cut in Spain's credit soured investors' risk appetites. The region's markets would have likely sold off more if it wasn't for the Bank of Japan's decision to boost its asset purchase program and corporate earnings that beat analyst estimates. Overall, the MSCI Asia Pacific Index fell 0.2%.

Looking at the regional markets the worst performers were the Japanese Nikkei and the Shanghai Composite, both down 0.4%. The Hang Seng finished 0.3% lower. On the flip side the Korean Kospi finished 0.6% higher while the Indian Sensex finished flat.

In Europe, equities are trading 0.2% higher in the aggregate while the region's blue chips are underperforming, down 0.2%. The overall European index is rallying due to strong earnings reports. Meanwhile at home, futures are pointing to a sell off later today. The S&P 500 is set to open 0.2% lower.

In bondland, Treasuries are bid due to Spain's credit downgrade. Both the five and ten year yields (1.92%) are 1bp lower while the long bond is down 2bp to 3.01%. In Europe, yields on Spain's 10-year are 11bp higher at 5.90% and Italy's 10-year note is 9bp higher at 5.71%. The safe havens of German and the UK are both bid.

The dollar is trading roughly flat in the currency markets while commodity prices are trading lower. WTI crude oil is off 46 cents to $104.09 a barrel and gold is up $3.64 an ounce to $1,653.79.

Overseas data wrap-up

Overnight, Spain's credit rating was downgraded by Standard & Poors from A to BBB+ with negative outlook. The downgrade itself is not unexpected given the deep recession the Spanish economy faces. The timing however caught the market by surprise. Yields on the country's 10-year note are 11bp higher than yesterday's close. While the downgrade doesn't change the outlook for Spain, in our opinion, it does serve as a reminder for the market that rating downgrades remain risk events for Europe in the coming months.

More bad news for Spain, the country's unemployment rate hit a record in the first quarter, rising to 24.4%. That's up from the previous quarter's 22.9% rate. Our European team expects unemployment to continue to rise as the economy falls deeper into recession. Normally when unemployment is on the rise we see inflation fall. However, Spain recorded an increase in inflation to 2.0% yoy in April up from 1.8%. The uptick in inflation is due to an increase in indirect taxes and also higher energy prices.

Japan released several indicators overnight. Industrial production was weaker than expected in March, only rising 1.0% mom following a 1.6% drop in the prior month. Consensus was looking for a 2.3% mom increase. In our view the Japanese data is inline with our view that production is still on a recovery trend but the pace of recovery seems to be slower than we originally thought. Thus the implications of this data set for the near-term economic outlook is negative but not very significant, in our view.

Other economic data from Japan showed that the country remains locked in deflation. The core measure of inflation fell 1.0% yoy in April. That is one reason that the BoJ at today's meeting decided to expand its purchase of long term bonds by ¥10tn, ETFs by ¥0.2tn and REITs by ¥0.01tn. All combined, the bank's asset purchase program increased by approximately ¥5tn, from ¥65tn to ¥70tn, to support additional monetary easing. Meanwhile the bank kept its policy rate at 0.0-0.1%.

Today's events

At 8:30 am, we'll be sorting through the first release of the first quarter GDP report. We expect first quarter real GDP to advance 2.3% at an annual rate after a 3.0% increase in Q4. With a 0.3ppt contribution from inventories, real final sales will expand 2.0%, suggesting modestly firmer domestic demand relative to last quarter when final sales ran just 1.1%. The demand will stem primarily from personal consumption, which we expect to rise 2.2%, contributing 1.5ppts to growth. Business spending on equipment and software will moderate, but still be rising while structures investment (commercial real estate) is expected to come under some pressure. Trade is expected to contribute a modest 0.1ppt to growth. While February's trade deficit narrowed sharply, we expect the BEA to anticipate some give back on trade in their first estimate.

The only other indicator on the data calendar is the final release of the University of Michigan consumer sentiment index at 9:55.