What German Bond Yields Are Telling Us
Justifiably, much of the media focus on global markets this past week has been on Southern European treasury yields, which spiked further upward as investors priced in an increasing likelihood of a Greek default. To me though, the far more interesting and meaningful market move of the week, has not been on Southern European bonds, but rather their Northern European counterparts. When the German 2-year treasury bond yield was trading at 0.70% earlier in the week, my colleagues at Business Monitor cautioned that the yield could fall further by up to 20bps. A day later, the yield had plummeted to a new record low of 0.59%. Of course, much of this has to do with the spike in risk aversion and flight to safety within the Eurozone that came with the collapse in the Greek and Portuguese treasury markets. That said, I think there is more to this story than simply risk aversion.
(Click on chart for full size)
Germany - 2-year treasury yield, %
Falling German yields (across the curve) has been a trend in play for several months now, suggesting that the markets are pricing down interest rate expectations in the eurozone through the long term. This would fit the broader macroeconomic theme of deleveraging and deflation in Southern Europe and low growth across the eurozone. Moreover though, should German yields fall to that 0.50% level my BMI colleagues mooted, than I think we would have to seriously contemplate the implications for ECB monetary policy. Beyond just pushing back the scheduled interest rate normalisation to 2011, the Greek crisis could yet result in another ECB cut. After all, the Czech National Bank surprised with a 25bps cut on May 6. The risks of ECB quantitative easing are also rising. After all, if a EUR110bn Greek bail-out package agreed to on May 1-2 was insufficient to calm the treasury markets in Southern Europe, than surely the next logical step forward is for the ECB to begin buying up government debt.In turn, this would add to the disaster befalling the euro. A move down to US$1.1600/EUR is looking more and more likely.
May 10th, 2010 at 8:16 am
Will EU, especially those rich member countries, face a situation in which: (1) declining inter-Europe trade due to shrinking demands especially from southern Europe; (2) higher import cost if RMB appreciate later this year; (3) lack of strong demand from USA. How EU / ECB prepare for such situation?
May 10th, 2010 at 11:00 am
In short answer: yes. Beyond the immediate financial problems stemming from Greece, the Eurozone is facing a long-term crisis of demand. Deleveraging and deflation in Southern Europe will assuredly result in declining eurozone trade and this will combine with fiscal austerity programmes, weak demographics, a weak labour market and low capacity utilisation to hamper private consumption and capital investment growth potential going forward. A lower trajectory for US private consumption growth beyond 2010 will only add to the problems. Chinese and emerging market demand will be one of the few bright spots for the eurozone. As I wrote about earlier on the blog, over the next 10 years I expect emerging market demand for German exports to exceed that of the eurozone.