Rising Global Rates Rattle the ECB | Lord Abbett
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Economic Insights

Policymakers employ forceful rhetoric amid a rare divergence in U.S. and Eurozone term premia.

Read time: 2 minute

With the 10-year U.S. Treasury yield up 10 basis points in the past week, it’s worth remembering that rising bond yields in the United States tend to have an upward influence on rates elsewhere.  But that doesn’t mean the European Central Bank (ECB) has to live with it. Indeed, several ECB officials have sounded the alarm in the past several days, employing some forceful language:1

  • Fabio Panetta: “A steeper nominal yield curve must be resisted” (March 2)
  • Francois Villeroy de Galhau: “We can and must react” to undue tightening (March 1)
  • Yannis Stournaras: There is “no fundamental justification” for the rise in long-term yields (February 26)
  • Isabel Schnabel: The ECB “may need to add support if yields hurt growth” (February 26)

We think the reason for their seeming panic is that in the past decade, it has been hard for the Eurozone term premium2 to diverge from its U.S. counterpart. However, like much else in today’s economic realm, the unusual has become commonplace (see Figure 1).  In December and January, the U.S. term premium increased as markets internalized improved forward-looking expectations of U.S. economic growth. Europe was largely unaffected. Next, fears of overheating in the United States hit bond markets amid an increased focus on the positive effects of stimulus legislation and accelerated vaccine rollout. With vaccinations lagging in Europe and a need to keep a tight lid on sovereign debt costs, the ECB started to hit the panic button, and policymaker rhetoric ratcheted higher.

 

Figure 1. Differing Recovery Prospects Prompt a Divergence in U.S. and Eurozone Term Premia

Eurozone versus U.S. term premium, January 2000–January 2021

Source: Federal Reserve Bank of New York and the University of Venice. The term premium is the estimated risk embedded in a longer-maturity bond that is determined by the difference between the actual yield and the “risk neutral” yield (represented by rolling a series of shorter-term securities extending to the same maturity at current rate expectations). For illustrative purposes only.

 

There are few times in the past decade where the two term premiums have diverged notably. In general, these two data series are highly correlated, underscoring the effect of the global bond level.3 In 2013, the U.S. Federal Reserve (Fed) attempted to tighten monetary policy, but the U.S. term premium was ultimately dragged back towards the Eurozone term premium since there was no strong, sustainable growth around the world. In 2021 it could be the opposite case. We could be on the verge of strong, sustainable growth in the United States—abetted by a continued recovery in China—and we believe this likely will force the Eurozone term premium towards the US term premium.

If this is the case, you can understand the ECB’s rapid and heightened level of concern. Europe isn’t quite ready yet for an increasing global rate level. The policymaker comments cited above point to an increase in the pace of bond purchases. To us, the main question is: Given this state of affairs, how long can the Euro resist depreciating versus other currencies? Clearly stronger growth, global trade, and commodities are positive influences on the common currency. But if the rate differential and increased quantitative easing pace can overwhelm the other factors, a weaker Euro is at least an acceptable consolation prize to the ECB as its member economies strive to boost growth.

 

1Sources: MarketWatch (first quote), Reuters (second and third quotes), and Bloomberg (fourth quote).

2As a reminder, the term premium is the estimated risk embedded in a longer-maturity bond that is determined by the difference between the actual yield and the “risk neutral” yield (represented by rolling a series of shorter-term securities extending to the same maturity at current rate expectations). Basically, it’s a gauge of the level of risk inherent in holding a longer-term bond versus a series of shorter-term securities.

3The “global bond level” is an empirical observation that recently the term premia of different countries’ yield curves are strongly correlated as a result of common inflation, demographic and monetary policy influences. Related research may be found at https://www.federalreserve.gov/PUBS/feds/2008/200825/200825pap.pdf

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

A basis point is one one-hundredth of a percentage point.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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