06:46 AM EDT, 07/30/2024 (MT Newswires) -- The above-forecast Q2 gross domestic product (GDP) data for France and Spain released earlier Tuesday challenge the prevailing perception including at the European Central Bank (ECB) that risks to growth are skewed to the downside in the eurozone, but it shouldn't change the immediate course of travel for interest rates, said Societe Generale.

The growth numbers make abstraction of the situation in Germany where the backdrop is more "challenging," wrote the bank in a note to clients. The ECB will take heart no doubt from the decline of core inflation in Spain to 2.8% y/y, the lowest since January 2022. Services stagnated at 3.7% but excluding rent ticked up to 3.9% from 3.8%, the highest since January.

The bond market isn't making too much of it and receiving flows continue to pressure yields and swaps to the downside across the curve, stated SocGen. The 10-year Bund sits right on the April low at 2.34% and the two-year Schatz extends below 2.60%. German CPI data is due later Tuesday.

The stasis EUR/USD is overshadowed by the rebound in EUR/JPY and yen (JPY) crosses by extension following the impressive turnaround in the Nikkei from -1% to +0.15%.

Meanwhile, downside growth risks have visibly materialized in Sweden, where the GDP indicator shocked on Monday with a 0.8% q/q contraction in Q2, pointed out the bank. The actual GDP print is not due until later in August, but the Riksbank's forecast is 0.02%. A significant downside miss, if confirmed, adds to the case for three, not two, additional rate cuts this year at the four meetings that remain. This does not augur well for the krona (SEK) in H2.

The Bank of Japan (BoJ) meets on Wednesday but SocGen's economists expect the policy rate of 0.10% (upper boundary) to be left unchanged. A hike would come as a shock and would potentially extend and exacerbate the volatility of the past few weeks with the liquidation of yen carry positions spilling over to other asset markets. The yen has cut losses by 4ppt against the US dollar (USD) since July 10 (until the squeeze back over 155 overnight) and this should take pressure off the central bank to raise rates for a second time after exiting negative rates in early spring.

The bank believes monthly Japanese government bond (JGB) purchases will be trimmed gradually to two trillion yen in 2026, slightly below consensus. At the last meeting in June, Governor Kazuo Ueda said that the tapering would be substantial.

This set in motion a rise in 10-year JGB yields from 0.90% to 1.10% in early July. The OIS 5y5y took off to almost 1.50% but surrendered 25bps over the past two weeks. Only 30% of economists surveyed by Bloomberg forecast a BoJ rate hike this week.

Risk reward is skewed to the upside if the BoJ stands pat and UST/JGB spreads widen if the BoJ underwhelms on reduced bond purchases. Conversely, a rate hike would probably accelerate the decline in USD/JPY to/below 150 this summer. Key support is at 151.60 (200dma).

In emerging markets (EM), the decision by China's central bank (PBoC) last week to drop the seven-day reverse repo rate by 10bps to 1.70% and the one-year medium-term loan facility (MLF) rate by 20bp to 2.30% delivered another tonic for local bonds, added SocGen. The 10-year CGB yield trades at 2.14%, well below the 2.20% level that not long ago was considered the new floor after the PBoC formulated its frustration with falling yields.

The PBoC recently announced that it has vast amounts of medium- and long-term bonds at its disposal to repo, after signing agreements with major financial institutions. The question is whether the central bank will tolerate a sustained fall in yields towards 2.0% or if it will intervene in the secondary markets after the Fed and BoJ meetings, according to the bank.

In India, bonds responded positively to fiscal consolidation in last week's budget. The 10-year IGB yield fell to 6.909%, the lowest since April 2022. Equities remain in demand despite the higher capital gains tax.

Czech Q2 GDP expanded by 0.3% q/q (0.4% y/y), short of consensus.

SocGen's view is for Q2 GDP growth in Mexico of 0.4% q/q later Tuesday, up from 0.3% in Q1.