The Macro 2 pagers – Low interest rates for a long time

The Macro 2 pager explains how the interest rates profile will remain low for an extended time. 
The central banks’ stimulus after the 2008 crisis has been caught up by an economy whose characteristics have changed and which can now accommodate only low rates thus conditioning the behavior of central banks.

The Macro 2 Pager – Interest Rates


Italy – The crisis is coming

The adjustment on the upside is not over on Italian rates. The 10 year bond’s rate is converging to 3%. The spread with the German 10-year rate is now circa 270 bp. This also reflects a safe heaven effect for German bonds.

With a rate at 3% % while the inflation is at 0.5% (in April), the real rate is way too high in Italy compared to real growth prospects. But such a level on the real rate (2.5%) would be just above the average seen since the beginning of the Euro Area (2.2%). It’s too high when the GDP trend is close to 1%. This has deterred investment and it will continue limiting the capacity to grow. We have to expect a slowdown in the economic activity in coming months. It will come from the real rate level but also from the uncertainty in the Italian economy. An austerity program that can be expected from a transition government is not good news for Italy but also for the rest of the Eurozone.

Higher bonds rates in China – Should we care?

Written with Zouhoure Bousbih

This week, the Chinese bond market has again been under selling pressure. The yield on 10-year Chinese government bonds once again flirted with the 4%, the highest in 3 years.
The Pboc (the Chinese Central Bank) intervened twice this week by injecting liquidity into the market, for a total amount of 810 billion yuan or USD 122bn , the largest injection since mid-January.
Should we worry?
No. The movement began just after the end of the C.C.P congress (end of October) when the Chinese authorities signaled clearly that they would continue their fight against high leveraged finance, ie shadow banking.
This has resulted in massive sales from Chinese government bondholders notably from  mutual funds that are the second largest holders of Chinese state bonds. They feared a tightening of financial conditions.
China’s interest rates have been low so far because of the loose Pboc’s monetary policy. The orientation has not changed but the action of the Chinese monetary policy is now more focused.
The Pboc intervened in the market by injecting liquidity in order to reduce volatility and it will continue to intervene if necessary to correct the excesses of the financial markets.
The Chinese central bank must find an equilibrium between its deleveraging campaign and the stabilization of Chinese financial markets so as not to penalize economic activity.

Does this question the attractiveness of the Chinese bond market for international investors? and the willingness of the Chinese authorities to open their bond market?
At 4%, Chinese government bonds remain attractive compared to their counterparts in developed countries,  helped by a stabilized yuan. China’s deleveraging campaign is rather a positive signal sent to international investors. China will not come back on the opening of its bond market to international investors because of the internationalization of the yuan. China’s economic activity remains sound. This is only a moment of turbulence to pass …

5 points to keep in mind after the Fed’s meeting

The Federal Reserve has kept unchanged its main interest rate in the corridor [0.25; 0.50%]. It will continue to reinvest the proceeds of its portfolio.

5 points to keep in mind

  1. In the press release the main change is related to the absence of reference to the global economy. It’s no more a source of break in the short term. The message on the economy is focused on the domestic side and on its momentum
  2. On this point the Fed is not worried. The central bank notices that employment and consumers’ real income follow strong trajectories. Nevertheless there are remarks on the low dynamics of investment and net exports.
  3. The balance of risks on growth and on inflation is not mentioned. The risk of a break in the economic momentum has been reduced in association with the withdrawal of references to the global context.
  4. The Fed doesn’t give signals on a possible rate hike at its next meeting in June. There is no specific message focused on June meeting, contrary to what was seen in October’s press release before the December meeting during which the Fed increased its main rate. Nevertheless the door remains open if it’s necessary. I doubt that the economic momentum will improve rapidly. I’m not convinced by the systematic catch-up of the second quarter (see the graph at the bottom of the post)
  5. There will be another question in June. The global environment will probably be more complicated. The Fed’s next meeting will be on June 14th and 15th. This will be just before the Brexit referendum (June 23rd). Nobody knows the issue of the referendum but it could create uncertainty in the UK and in Europe. Moreover we will also have general elections in Spain (before June 26 probably), the second round in Austrian presidential elections and we don’t know yet how the Greek issue will be solved. In other words, if systemic uncertainty grows on Europe, US assets could be perceived as safe haven. Therefore, in this environment the Fed could keep its rate unchanged at its June meeting.