William De Vijlder

Group Chief Economist BNP Paribas

US: rising bond yields, a concern for equity investors?

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The cost of (talking about) public debt cancellation

Recently, several calls have been made for the ECB to cancel part of its government debt holdings.Such an operation would violate the EU Treaty. On economic grounds, it is unnecessary, given that the interest paid on the debt to the ECB flows back to governments in the form of dividends. It would actually entail a cost: higher inflation expectations and/or a higher inflation risk premium would cause an increase in bond yields. The extreme nature of the measure could also undermine confidence. In reality, the very low levels of interest rates imply that governments have a lot of time to bring their finances in better shape.Finally, should senior policy makers merely talk about the possibility of debt cancellation, this could also entail a cost: financial markets could consider that the unthinkable is gradually becoming less unthinkable.

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Public finance

US fiscal stimulus: doing not enough is the greater risk

The dire state of the labour market requires a major support effort for the economy. This view is shared by Fed Chairman Jerome Powell and Treasury Secretary Yellen. The massive fiscal stimulus plan prepared by the Biden administration has received criticism from prominent economists. They argue that the plan is too big and could trigger a sizeable increase in inflation. In deciding on the size of the fiscal plan, risk management considerations play an important role. Doing not enough is clearly the greater risk. However, doing a lot will eventually force the Federal Reserve to demonstrate its independence by not shying away from raising rates despite the impact on government finances.

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EcoTV

Towards a pick-up in euro area inflation after all?

Euro area headline inflation has been in negative territory for several months and core inflation is stuck at a very low level. Unemployment is expected to rise further before starting to decline, so wage increases should remain limited. Does this mean that inflation is bound to remain low for a long time? Not necessarily.

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Inflation

Eurozone inflation: more noise than signal

The preliminary estimation for euro area inflation surprised to the upside, with annual core inflation reaching 1.4% in January. Monthly inflation was negative however, at -0.5%. Due to the Covid-19 pandemic, inflation data have become very noisy and hence more difficult to interpret. Survey data show rising input prices and lengthening of delivery times, which could exert some upward pressure on inflation. These factors should dissipate during the course of the year. Given the economic slack, any lasting pick-up in inflation should be a very gradual process

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EcoTVW

Towards a delayed eurozone recovery?

With the pace of vaccination roll-out, new infections in many countries and the emergence of variants, there is a risk that restrictions may need to be kept in place. This would induce a delay in the recovery. In the sectors impacted by the restrictions, the difficult times would last longer and could lead to bigger damage. Finally, an international comparison of the recovery pace could have an impact on capital flows and the euro, given that the eurozone is lagging behind.

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Wall Street

Call options as lottery tickets: does it matter?

Academic research shows that certain investors look at single stock call options as lottery tickets. They are aware they can lose money but nurture the hope of very big gains. To some extent, the share price behaviour in recent days of certain US small cap stocks illustrates this thinking. The combination of herd-type momentum buying and a short squeeze has caused huge share price swings. Should this become a recurrent phenomenon, it might reduce the informational efficiency of equity prices, increase the required equity risk premium and influence the cost of capital of companies.

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Dollar/euro

The (un)surprising weakening of the dollar and what could change it

 In recent months, the dollar has weakened versus the euro although the real bond yield differential between US Treasuries and Bunds has increased. Amongst the factors that may explain this development, Federal Reserve policy is particularly important through its impact on capital outflows from the US and currency hedging behaviour of eurozone investors. The biggest risk for a change in direction of the dollar would be a repetition of the ‘taper tantrum’ of 2013 with the Federal Reserve starting to point towards a possible beginning of the normalisation of its policy. However, such a change in guidance is not to be expected anytime soon.

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Bonds

The puzzling disconnect between Treasury and Bund yields

Yields on US Treasuries and German Bunds tend to be highly correlated but since the end of August, Bund yields have been essentially stable whereas treasury yields have increased.This spread widening is explained by a rising real rate differential, to a large degree due to a decline in German real yields. This could reflect a more gloomy view of bond investors about the growth outlook in Germany and, by extension, the Eurozone. Another, more likely, interpretation is that the real rate risk premium has declined in Germany due to the asset purchases of the ECB. In such case, investors will become increasingly nervous about the prospect that in a post-pandemic world the ECB will eventually have to stop the net purchases under its PEPP.

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Public debt

Why the level of public indebtedness matters – A market perspective

It is quite likely that, going forward, fighting recessions will be the remit of governments with central banks facilitating this task by creating cheap financing conditions. As a consequence, public indebtedness may very well remain high.One should wonder whether this could end up having negative consequences. A possible transmission channel is the pricing of government debt via a sovereign risk premium. Another factor can also play a role. Since 2015, when German bond yields increased, the rise in Italian yields has been even bigger -so the spread widens- whereas French yields have increased in line with German yields. These results suggests that, even in an environment of public sector securities purchases by the ECB, the high level of Italian debt influences the reaction to movements in Bund yields. Clearly, in the absence of QE, one would expect this effect to be at least as powerful.

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EcoTV 7 janvier

What difference will the pace of vaccination make for the economy?

The introduction of vaccines will enable the global economy to make the shift from a stuttering recovery, shaped by a series of lockdowns and their relaxations, towards a steadier growth trend. A key factor will be the gradual reduction in uncertainty, which will encourage households to spend and businesses to invest. The quicker we reach collective immunity, the stronger this economic momentum will be.

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Illustration édito 20.47

Economic outlook: the narratives of 2020

Narratives –the stories people tell about events- may influence behaviour. In future years, several narratives may very well be used when looking back at economic developments in 2020. Big, unanticipated shocks do happen. In terms of monetary policy, a ‘whatever it takes’ attitude prevails. This also applies increasingly to fiscal policy. In terms of financial markets, the dominant attitude towards risky assets is to buy rather than to say ‘bye bye’. With Next Generation EU, the European Union has again demonstrated that, under pressure, it can make big leaps forward. Finally, attention to sustainable growth has become ubiquitous. Some of these narratives provide comfort but several also come with a warning.

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2020 / Covid-19

2020: Entering a new era

2020 will leave its mark in History owing to the economic consequences of the Covid-19 pandemic. The pandemic notably triggered a disruption of the supply-side, led central banks and governments to adjust fiscal and monetary policies to face the crisis.

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2021- Vaccin

After a most difficult year, cautiously hopeful for 2021

Until the very end, 2020 has been a difficult year, to say the least. However, there are reasons to be cautiously hopeful about the economy in 2021. Vaccination should reduce the uncertainty about the economic outlook. Ongoing fiscal and monetary support is also important. However, more than ever, caution is necessary in making forecasts. Reaching herd immunity may take longer than expected and some of the economic consequences of the pandemic may only manifest themselves over time.

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EcoTV du 16 décembre 2020

2020 economic review: agile responses to the Covid-19 shock

Covid-19 represents an exogenous shock to the global economy of unseen proportions in recent decades. The reaction has been swift and agile. Central banks have eased policy and injected liquidity whereas governments have put fiscal discipline aside and used their budgets to bring much-needed support. This has softened the blow from the pandemic. What has also played a role is the agility of companies by adapting their production and/or distribution models to cope with the disruption of supply chains and the impact of restrictions on sales and by making it possible for a lot of their staff to work from home. Most importantly, the development of a vaccine brings hope at the end of a very difficult and challenging year. Vaccination should lead to a lasting economic recovery although questions remain about the possible longer-lasting impact of the pandemic in terms of unemployment and corporate as well as public sector indebtedness.

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Wall Street

The US stock market and the labour market worlds apart?

In the US, the behaviour of the equity market versus the level of employment is very different in the current recession compared to previous recessions. The recession this year stands out because of its sudden, enormous job losses, which were quickly followed by a significant albeit very incomplete recovery. The equity market, after a huge drop, has rebounded swiftly and made new highs although earnings –on a 12 month moving average basis- still have to rebound. For 2021, more than anything, earnings growth matters.

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Monetary policy: today’s relief, tomorrow’s headache?

The Federal Reserve and the ECB have been highly successful in influencing asset prices as part of their effort to cushion the shock to the economy from the Covid-19 pandemic. However, one might wonder whether today’s relief could cause an investor’s headache tomorrow. The difficulty of an exit strategy does not imply that certain monetary tools should not be used in the first place. After all, they do have positive effects. However, the likelihood of a bumpy normalisation process of monetary policy calls for careful preparation by central banks as well as investors. These considerations could become particularly relevant should the recovery in 2021 end up surprising to the upside.

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Incertitude

What if the road to Covid-19 immunity is longer than expected?

The prospect of the deployment of a Covid-19 vaccine has raised expectations that the stop-start cycle seen this year will make way for a lasting economic recovery in 2021. There is concern however that bringing the pandemic under control could take more time than is currently assumed in economic projections. Under such a scenario, worries about possible new restrictions would remain elevated, although one can assume that, because of vaccination, these measures would be less strict than before and more local.Nevertheless, in the more exposed sectors, investment and employment could be clear victims.

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Inflation

Pent-up demand to trigger inflation pick-up

The Covid-19 pandemic has caused a decline in inflation and, in most euro area countries, an increase in the inflation dispersion between sectors. It will take considerable time until activity has been restored sufficiently to generate labour market bottlenecks, which –in the absence of exogenous shocks- are a necessary condition to see a broad-based and lasting increase in inflation. This suggests that for the coming years, we should expect inflation to fluctuate around a slowly rising trend. In the course of 2021, the unleashing of pent-up demand –under the assumption that a vaccine is sufficiently widely deployed- could cause a temporary pick-up in inflation. In this respect, a decline in the price elasticity of demand will play a key role.

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Blog édito 20.42

Announcement of vaccine cuts tail risk

The announcement that a Covid-19 vaccine that is under development is highly effective caused major reactions in financial markets, reflecting a feeling that the growth outlook has changed. The prospect of a vaccine offers hope that in the medium run activity will normalise, but the positive impact on growth will take time to materialise. Clearly, the view that better times are ahead of us very much depends on the horizon one takes. However, decisions of households and businesses not only depend on expected growth of income and profits but also on the distribution around the growth forecast. The prospect of a vaccine reduces the probability of very negative outcomes and this reduction in uncertainty should eventually contribute to a pick-up in growth.

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Illustration blog EcoTV du 13/11/2020

The stop-go recovery

After a mechanical and spectacular recovery in economic activity during the third quarter, there seems to be a real risk that the euro zone will see the recovery come to an abrupt halt in the final quarter of the year. This will be due to the sharp rise in the number of new coronavirus cases, the measures taken to restrict the spread of the disease and the general feeling of uncertainty that will hold back spending. This said, we can already look forward to the impetus to recovery from a relaxation of these measures once the number of new cases has been brought back under control. We are therefore living in a stop-start economy, with strong acceleration alternating with brutal slowdowns. Such an environment, with its lack of visibility beyond the short term, is depressing the propensity of businesses to invest. Households may also delay spending on large-ticket items. Monetary and, to an even greater extent, fiscal support will thus remain crucial. Spillover effects from the rest of the world will also play a key role. In this context, one thinks of China and of the USA, where a new stimulus package is being drawn up.

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William De Vijlder

About William De Vijlder

Group Chief
Economist
BNP Paribas
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