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Inertia of long-term rates in the US and the euro zone, stable Chinese growth

Macro Highlights - 4/25/2018

In short
  • Despite the rise in oil prices, 10-year yields have remained low in the US and the euro zone, due to investors’ wait-and-see attitude in light of international trade tensions...
  • ... these low yields could persist if, as we expect, central banks confirm that they intend to use caution in the context of increased uncertainty
  • In China, real GDP growth was stable at 6.8% in Q1 2018 for the third quarter in a row. The slowdown in credit growth continued in March

Bond yields – trade tensions are weighing on long-term yields in the US and the Euro Zone

The growing tension on trade issues between the US and China over the past weeks has affected long-term rates in the US and the euro zone. 10-year sovereign yields, which had reached a high point in February 2018, have fallen slightly on both sides of the Atlantic. Thus, the yield on the US 10-year Treasury, which was at 2.95% on 21 February, was recorded at 2.91% at the close of 19 April. Likewise, the yield on the German 10-year Bund was at 0.60% on 19 April, after reaching a peak of 0.77% on 2 February.

These low long-term yields have led to a flattening of curves. In the US, while the yield on the 2-year Treasury note increased from 2.27% to 2.43% between 21 February and 14 April, after the Fed raised its key rate, the spread between the 10-year and the 2-year narrowed by 20bp to 48bp. In Germany, on 19 April, the 2-year Schatz was at a level close to that of 2 February, i.e. - 0.56%. As a result, the German yield curve has flattened by 15bp to 16bp.

This trend in long-term yields is especially notable due to the fact that oil prices have risen significantly over the past several weeks, mainly as a result of growing uncertainties surrounding geopolitical risk, pending the upcoming decision by the US on possible new economic sanctions against Iran. The price of the barrel of physical WTI was at $68.5 on 18 April, i.e. its highest level since December 2014, and the price of Brent reached $73.9/bbl, its highest since November 2014.

The trend in inflation expectations confirmed that investors’ reaction to the new rise in oil prices was very moderate. In the United States, the 10-year inflation swap rate was at 2.36% on 19 April, i.e. the same as its peak in February 2018, which is still below the average of 2.55% between 2010 and mid-2014. In the euro zone, the 10-year inflation swap rate was 1.55% on 19 April, after reaching 1.61% in January 2018, below its average between 2010 and mid-2014, which was 2.06%.

Implications:

According to our analysis, the inertia of yields and long-term inflation expectations in the US and the euro zone reflects the waitand-see attitude of investors in a context in which the risk of a trade war raises uncertainty with regard to the economic outlook on both sides of the Atlantic. The relatively low yields could persist, moreover, if, as we expect, the growing economic uncertainty leads central banks to confirm their intentions to remain cautious and that, as a result, they could delay the normalisation of their monetary policies if necessary.

China – growth remained stable at 6.8% in the first quarter

In China, real annual GDP growth came in at 6.8% for the first quarter of 2018, the same pace as the previous two quarters. The contribution of final consumption to total growth increased from 4.1% in Q4 2017 to 5.3% in Q1 2018 (see left-hand chart). Retail sales mirrored this trend. They were up 10.1% in March, i.e. average growth of 9.7% for the first quarter of the year.
Growth was driven by most sub-components, and automobile sales in particular, which had undergone a sharp deceleration in 2017 under the effect of the end of fiscal incentives for vehicle purchases. The relatively stable growth in the disposable income of urban households at 8.0% during the quarter reflected the resilient consumption trend in China. The inflation context – with a slowdown in March to 2.1%, significantly below the 3% target of the People’s Bank of China – was also a factor that supported domestic consumption. Year-on-year growth in investments in fixed assets slowed slightly to 7.1% in March, vs. 7.2% at the end of 2017, due notably to the decrease in investment in infrastructure, which was penalised in particular by the tightening of conditions for local government financing for certain public projects.

Credit growth continued to decelerate in March. There was a more marked deceleration for aggregate credit – which includes part of the shadow banking market – than banking credit. Bank credit growth slowed very slightly to 12.7% in March (see righthand chart), while aggregate credit grew 10.5% in March compared to 11.1% for the first two months of the year. This trend echoes the 19th National Congress of the Communist Party, which had formalised the control of financial risks and the deleveraging of the Chinese economy and made them a top priority. This slowdown in credit – especially the shadow banking components – is thus set to continue over the upcoming months.

Sophie Casanova – Economist, Central Banks
François Léonet - Economist, Emerging Markets