Olivier de Berranger

MACROSCOPE : March 2nd

Thaw in rates

Government rates in Europe have been held in negative territory for a long time, but some saw a slight thaw recently, either to a less negative level, such as the 10-year Bund that moved from around -0.60% at the beginning of January to -0.25% on 25 February, or even into positive territory like French 10-year rates. Although this is good news in itself since negative rates are the reflection of a depressed economy, just as you might experience aches and pains coming back inside on a cold day, this thaw in rates is accompanied by some suffering. Equity markets were tense last week, or at least one particular segment was – the most expensive stocks, such as certain tech names or those linked to energy transition. They had been such beneficiaries of consistently falling rates and the COVID-19 crisis that their correction was logical, even healthy.

Slow return to normality in Europe

Markets are starting to return to some semblance of normality: an idyllic situation rarely seen of positive interest rates, strong growth, and inflation “below, but close to, 2%”, as the ECB mantra goes. But this is only the start of a return to normality: the majority of European rates are currently still in negative territory. And in particular, all real rates (nominal interest rates less inflation) remain frozen at below zero, since expected long-term inflation for the eurozone is currently around 1.3%*, significantly higher than most government rates in the region.

The starting point of this sudden thaw is sadly not in the eurozone, but in the US. 10-year rates there have moved from a level close to 0.90% at the beginning of the year, to over 1.50% recently, i.e. to the level they were at before the COVID-19 crisis. The fall in infections, a more supple monetary policy on inflation control and an extremely proactive fiscal policy since the arrival of Joe Biden are combining to provide a glimpse of strong growth acceleration in 2021, soaring consumption and a normalisation of inflation. Of course, these elements are all present in Europe, but to a far lesser extent. As was the case with vaccinations and digitalisation, and in so many other areas, the eurozone has simply benefited from the improvement coming from across the pond.

Can this movement go further? We can only hope so, even if this would be extremely painful for shareholders of the most expensive stocks and for debtors, who will see their assets depreciate. This painful transition would primarily affect everything that is overvalued (and possibly the rest from contagion), but wouldn’t it be preferable to a depressed status quo? A return to positive interest rates would enable the economy to exit an absurd situation in which we are paying governments and the best companies to lend them money.

Central banks fail to melt iceberg of global debt

Without doubt, other painful matters will resurface subsequently. In particular, we will remember that, in principle, borrowing costs money. Governments will no longer be able to borrow “regardless of the costs”**. Taxpayers and the beneficiaries of state subsidies alike will feel the difference. But that’s a long way off, at least in Europe. By that time, it is not inconceivable that central banks will have set aside some government debts in one way or another, as they certainly will not risk letting the iceberg of global debt melt. The effect of any such warming would be almost as dramatic as that of the planet, but thankfully, it is easier to control. So let’s welcome this financial warming as good news, and rely on central banks to be on hand with the anaesthetic required to calm any pain that would be caused by its escalation.

* Eurozone 5-year, 5-year forward inflation swap.
**Emmanuel Macron, 2020


Authors : Olivier de Berranger, CIO ; Enguerrand Artaz, Fund Manager

Final version of 26 February 2021