More government spending may be needed in Europe to close the growth rate gap with the U.S.
The contrast is stark: U.S.10-year Treasury yields are at roughly 1.70%, while German 10-year Bunds have a negative yield of -0.59% – a differential of nearly 230 basis points (bps).1
That sharp rate differential reflects the relative prospects of the two economies, with Eurozone growth and other economic measures continuing to fall short of even the relatively pessimistic expectations of the European Central Bank (ECB). In contrast, the U.S. generally has been surprising to the upside since June 2019. That’s very evident in the chart below, which reflects the degree to which the regions fall short or exceed expectations for a range of indicators; positive figures signal overall outperformance, and negative figures signal overall underperformance.
Source: Bloomberg, as of 9/26/19. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
That divergence helps explain the urgency behind the ECB’s enthusiasm for driving its already-negative benchmark deposit rate even lower, vs. the Federal Reserve’s Open Market Committee (FOMC), which appeared somewhat divided about whether rates or not should be brought down further in the wake of its mid-September meeting.
One source of U.S. resilience could well be the upward march of government spending, a de facto fiscal stimulus not currently being matched in Europe, thanks in part to political complexities, and in part to the fiscal conservatism of key stakeholders, including Germany itself.
On the rise: Puerto Rico’s debt deal
After years of bankruptcy negotiations about how to resolve the island’s enormous public debt, widely held by U.S. investors, authorities announced a new plan that would renegotiate approximately one-third of its $129 billion exposure.
That $35 billion will be replaced by $12 billion worth of bonds payable over the next 30 years; in connection with other deals reached earlier this year, the agreement paves the way for bankruptcy to be lifted later in 2019. The island suspended payments in 2016 pending renegotiation with creditors.
On the slide: Bank of Japan asset purchases
The Bank of Japan announced last Monday that it would begin reducing the amount of bonds it would buy next month—focusing its efforts on longer-dated maturities. The move was widely perceived as an attempt to increase the spread between short-term and longer-term rates and thereby steepen the slope of the yield curve.
That’s a change that Japan’s financial sector would presumably welcome, given the crushing pressure on lending margins that’s come from the ultra-low rate policy of its central bank. The BoJ had committed to a target yield of 0% for 10-year government bonds, but a general decline in global bond yields helped push market yields down to -0.2%, forcing the Bank’s hand.
1 Source: Bloomberg, September 26, 2019, 3:45 PM ET [Bloomberg function WBX].
The Bank of Japan (BoJ) is the central bank of Japan and is responsible for the yen currency
A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
Bunds refers to bonds issued by Germany's federal government. Bunds are available in 10- and 30-year maturities.
The Citi Economic Surprise Indices measure data surprises relative to market expectations. A positive reading means that data releases have been stronger than expected and a negative reading means that data releases have been worse than expected.
The European Central Bank (ECB) is responsible for the monetary system of the European Union (EU) and the euro currency.
The U.S. Federal Reserve, or “Fed,” is responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.