Eurozone bond markets (part 1) – economic background

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The risk aversion of late-2018 may have given way to a sharp rebound in risky assets on financial markets, but newsflow early in 2019 merely confirmed concerns over the prospects for global growth. Forecasters (official and private sector) repeatedly downgraded their economic outlooks during the first quarter. The slowdown in German industry was particularly marked.

  • Signs of a slowdown
  • A brighter outlook
  • A focus on fiscal policies in 2019

A soft landing for global growth

Industrial indicators on global growth are pointing clearly downward, especially in Germany. What is more, clouds continue to overhang the economic environment, including Brexit, the slowdown in Chinese growth and a self-fulfilling risk-off scenario in markets. This bad news, though, has been more than sufficiently integrated into economists’ forecasts and market prices.

Leading indicators on global trade have ticked up slightly, notably the Harper Petersen shipping index. One swallow does not make a summer, but the latest indicators for Chinese growth have at least turned positive. Finally, budget stimuli in France, Italy and Germany, coupled with improved financial conditions in the US should provide a boost over the next two quarters.

US growth shows signs of flagging

The latest indicators for US growth are down and the jobs market has reached such high levels that it is hard to see much scope for further improvement: the U6 measure of unemployment (which includes the rate of underemployment) fell to 7.3%, close to its 25-year low (6.9% in 2000).

Having said this, markets have been overhasty and forgotten the negative impact of the US government shutdown, such that data published so far have likely overestimated the drag on growth early in the year.

What’s more, financing conditions, which had tightened sharply in the US at the end of 2018 (notably due to rises in credit card and car- finance rates), eased considerably in first quarter 2019, helping to sustain growth. These potential improvements have been corroborated by the Atlanta Fed’s Q1 GDP growth indicator, up to 2.1% from a low of 0.17% mid-March.

A clear slowdown in German growth

While the industrial data for Germany (and most of its partners) were terrible throughout the first quarter, they overstate the scale of the problem for the eurozone as a whole. Services did not suffer a similar slump. In fact, services PMIs in the eurozone have rebounded since the start of the year back to November 2018 levels, a threshold set in late 2016. The next two quarters should also benefit from two other positive factors: cheaper oil than at the end of last year and tax stimulus.

German industry is still under the cosh, particularly from slowing vehicle sales around the world (China’s slumped by 17% year-on-year to April) and the arrival of new vehicle pollution standards in Europe.

The European Commission’s economic sentiment indicator remains high but has been falling steadily for months. Now, though, it has stabilised in most major economies (France, Spain, Italy), Germany being the exception.

Fiscal stimulus, most notably in France and Italy but also in Germany, and a lower euro (against a basket of 19 currencies) since mid-2017 should support growth in the Eurozone over the next two quarters (French statistics authority INSEE foresees growth of 0.4% in each of the year’s first two quarters).

Eurozone exports have suffered from the slowdown in Chinese growth. Here too, though, steps have been taken to relaunch consumption and Chinese PMI indicators have turned up again, including in manufacturing.

The job market remains dynamic on average in the eurozone, despite a dip in hiring intentions in industry: the job vacancy rate is at a high since 2004. However, unemployment has been slow to fall since July (7.8% at end-February against 8% at end-summer, its lowest level since October 2008 according to Eurostat figures).

Italy’s growth outlook has worsened to the point where it is flirting with recession. Nevertheless, the respite Italy is currently enjoying on the markets could last for some weeks to come if S&P decides not to downgrade its sovereign rating on 26 April.

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Arnaud-Guilhem Lamy

Co-head of aggregate specialty fixed income

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