European Bond Yields at Record Lows

ireland spain italy bond sale

european-countries-ssEuropean Bond yields reached record lows this past week.

For example, the yield on the 10-year German bund dropped below 1.00 percent at various times.  Yields in Italy and Spain also hit record lows.

These lows are not the result of the European Central Bank or of other governmental policies.  The rates are low because the economies of Europe are experiencing some pretty rough times.

None of the big three European countries grew in the second quarter of 2014.  Italy reported its second quarter in a row with negative growth…making this the third recession in this country in the last five years.

And, price inflation continues to drop with the expectation that disinflation will turn into actual price deflation in the near future.  The fear…a Japanese-style deflation where the eurozone stays in stagnation for an extended period of time.

This situation is resulting in additional pressure being put on Mario Draghi, president of the European Central Bank, to move the ECB to a policy of quantitative easing.  So far, Mr. Draghi has resisted this pressure and is following a policy of very low interest rates…one policy rate is actually negative…but remains relatively disciplined in terms of over-doing the monetary ease.

The problem is that the economies of the countries in the eurozone, including Germany, are very export driven.  With the American economy only showing signs of tepid growth and with China and the rest of the world experiencing lower than normal economic growth, eurozone exports are stuck.

And, with the economies of the eurozone facing low levels of productivity the competitiveness of their products fall somewhat short in a world that is growing more and more competitive.

Structural reform seems to be the only answer to the competitive position of these countries…but, structural reform takes time and many are saying that the eurozone does not have that time.

Fiscal policies are stymied because of the deficit constraints that the European Union has imposed on its membership.  Thus, monetary policy is the only game in town.

So, as Mohamed El-Erian has written in BloombergView there is a real question about how central bank policies will impact the global environment.

“After a long period in which the world’s largest central banks were all pushing in the same direction, they’re now reaching the point where their policies will diverge. The Bank of England and the Fed are in the process of taking their foot off the stimulus pedal. The European Central Bank and the Bank of Japan will be going the other way. This multispeed world of increasingly contrasting policies could have big effects on markets and people far beyond the U.S., Europe and Japan.”

Japan’s economy dipped at a negative 8.6 percent rate in the second quarter of this year.

Whereas higher interest rates in the United States and England should help to further reduce the value of the Euro and help exports from the eurozone, the higher rates will also draw funds from the eurozone chasing these higher interest rates.

As I wrote last week, the United States has already been attracting funds from Europe as it has served as a “safe haven” for monies concerned with the financial condition of the continent.

Still, the eurozone economies do not give any appearance of picking up speed anytime soon.  Thus, there seems little reason to believe that the yields on European sovereign debt will rise anytime soon…unless there is a collapse somewhere and risk premiums shoot up again on some issues.

So, low longer-term interest rates go with economies that are weak and are showing a lack of pressure on prices.  Of course, in such economies prices might actually be declining.  If the European Central Bank actually goes into a mode of quantitative easing, it is my belief that longer-term interest rates will not go down much further…if at all.

The only time I can see lower longer-term yields on the continent is if the eurozone goes into another deep recession.  Let’s hope that this can be avoided.

About John Mason
 John MasonJohn has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.


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