William De Vijlder

Group Chief Economist BNP Paribas

US inflation: increasing discomfort

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Dépenses ménages

How to spend it? Shifting consumption patterns and Covid-19

The Covid-19 pandemic is having a profound impact on household expenditures. The volume has dropped and its composition has changed significantly. As restrictions are gradually lifted, services such as recreation, food services and accommodation, which have seen a big reduction in demand due to the restrictive measures, could thrive, to the detriment –at least relatively speaking- of spending on goods. For the strength of the early phases of the recovery, pent-up demand is an important factor. It plays a smaller role in the services sector, which could mean that countries with a larger services sector not only have suffered more from restrictive measures but could also face a bigger challenge during the recovery.

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Central banks and climate change

Central banks have become increasingly aware of the impact of climate change on price and financial stability. Moreover, by accepting collateral or via asset purchases, central banks are taking explicitly climate risks on their balance sheets. At the European Central Bank, climate change has become integral part of the monetary strategy review launched in 2020. A major question is whether climate objectives should be pursued in the conduct of monetary policy. The fear is that it could be seen as “mission creep”. At a minimum, one would expect the ECB to ask for more disclosure concerning climate-related factors for assets held on its balance sheet. But the question to what extent market neutrality should be abandoned in favour of greener objectives is still open. The outcome of the review should be announced in September 2021.

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EcoTV Avril 2021

Spring is in the air

Economic statistics for the first part of this year are better than expected, including in Japan and the euro area. Moreover, this development is broadening in terms of sectors. Looking at business surveys, there is a growing feeling of beginning to “see the light at the end of the tunnel”.

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Illustration édito EcoP

Growing certainty that there will be less uncertainty

In many countries the number of new Covid-19 cases has begun rising again, forcing governments to maintain or tighten health restrictions. This is the case for the Eurozone, among others, where a true rebound in growth and demand has been postponed yet again. The timing of the recovery will depend essentially on the effectiveness of restrictive measures and the acceleration of vaccination campaigns, but also on spillovers effects with some of its trading partners whose economies are picking up more rapidly. The United States is one such country thanks to its successful vaccination campaign and the enormous recovery plan that has just been launched. America’s influence is not limited to providing greater opportunities for European exporters. The upturn in US bond yields has partially carried over to long-term rates in the Eurozone, pushing them higher. This trend largely reflects higher inflation expectations, although the Federal Reserve is convinced that the surge in inflation will be short-lived. Companies and households should welcome the bond markets’ jitters, which clearly signal the sentiment that the economy really is improving.

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Printemps - bourgeons

Eurozone: green shoots of recovery

The emergence of spring mirrors the improvement in economic data in the euro zone. When looking at the recent flash PMIs, one cannot but be impressed by an improvement far bigger than what was expected by the consensus. The manufacturing PMIs are also reaching a very high level and sometimes historical levels. Services have also improved, however the level is still lower than the long-term average.

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After disconnecting, will money supply growth and inflation reconnect?

Since the Great Recession, the monetary base in several advanced economies has seen a considerable increase, driven by the creation of bank reserves at the central bank. Yet, contrary to what had been observed in previous decades, this has not been followed by a significant pick-up of inflation. Following the global financial crisis, the demand of the banking system for central bank reserves increased a lot. This was a reflection of the dire state of the economy and money markets as well as tighter liquidity requirements. Subsequently, quantitative easing caused an increase in reserves on the initiative of the central bank. Going forward, as the economy strengthens, money supply growth and inflation could reconnect on the back of an increase in money velocity or faster credit demand growth. Central banks have the tools to address this, if need be. Clearly, asset markets might be less relaxed about such a prospect.

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Inflation

US: nail-biting about the near-term inflation outlook

In recent months, purchasing managers in the euro area and the US have reported a significant increase in input prices as well as longer delivery lags. They reflect the next stage of the disruptive impact of the pandemic with supply struggling to meet the pick-up in demand. According to an Atlanta Fed survey, firms experiencing the most intense disruption tend to be those with the highest expectation of future inflation. It remains to be seen whether this will convince them to raise prices. The Federal Reserve is relaxed about this but, nevertheless, there will be lot of nail-biting in the second half of the year as US inflation data are released in an economy that should be able to close its output gap quickly.

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FOMC

US: trying to read the mind of the Federal Reserve

The new economic projections of the FOMC members reflect a big but temporary boost to growth from the fiscal stimulus and the normalisation of economic activity as the adult population is vaccinated. They expect a limited, temporary increase of inflation. Four participants now expect that the circumstances would warrant an increase in the federal funds rate next year. Seven expect this to be the case in 2023. Fed chairman Powell was quick to point out that the projections are not a committee forecast and that the data do not justify a change in policy. This message clearly anchors short-term interest rates, whereas longer-term bond yields fluctuate on the waves of ease or unease about where the federal funds rate could be several years into the future.

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Cybermonnaie

Bitcoin: buyer beware

Based on an overview of the functions of a currency, cryptocurrencies should be considered as an investment instrument, rather than as an alternative to fiat money. Since the start of 2020, correlations between bitcoin and copper, equities and, in particular, breakeven inflation have increased. Probably, investors turn to bitcoin when inflation expectations are on the rise.  Swings in investor sentiment also play a role. The extent of the change in the bitcoin price suggests that speculative waves are at work, driven by momentum buying and extrapolative expectations of price appreciation. When the fundamental value of an instrument like a cryptocurrency is very hard if not impossible to determine and when short-term price changes are a multiple of those observed in equity markets, caution should prevail when building and managing an exposure.  

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EcoTV 20210311

The bond market turmoil: causes and consequences

In recent months, US government bond yields increased significantly on the back of higher inflation expectations but more recently, higher real rates have been the key driver. The latter development is in turn related to the prospect of massive additional fiscal stimulus. Unsurprisingly, the dynamics in the Treasury market have had global spillover effects, raising concern about an unwanted tightening of financial conditions.

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Towards an unwelcome tightening of financial conditions in the euro area?

The financial cycle, as captured by bond and equity market developments is very much globally synchronised, but, at present, there is a business cycle desynchronization between the US and the euro area. Rising euro area government bond yields, on the back of higher US yields, cannot be considered as a sign of economic strength. Quite to the contrary, they come at a bad moment. One would expect, at a minimum, a very strong statement from the ECB’s Governing Council on 11 March on its decisiveness to act should yields continue to rise. Markets would of course prefer immediate action. After all, the tool –the PEPP- is available so one might as well step up its use.

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Illustration ECOTV Mars

Does the rise of bond yields call for yield curve control?

Should central banks adopt a policy of yield curve control ? This debate has intensified following the important upward move of US bond yields. Central banks watchers are wondering what is the best reaction to adopt faced with this increase in bond yields. As a reminder, the increase in US bond yields is occurring against the background of an economy which is recovering, an additional major stimulus package which has been prepared by the Biden Administration, an ongoing very accommodating monetary environment and a very successful vaccination campaign.

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Bonds

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

Until recently, the rise in long-term interest rates did not stop the equity market from moving higher, but events this week suggest investors are becoming increasingly concerned. The possible impact of higher bond yields on share prices, depends on what causes the increase: faster growth, a decline in uncertainty, rising inflation expectations.The last factor is the trickiest one because it may cause a profound reassessment of the outlook for monetary policy. Over the past two decades, the relationship between rising rates and the equity market has not been statistically significant. Gradualism in monetary policy has played a role. Recent statements by Jerome Powell show he is very much aware of the importance of avoiding to create surprises.

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Dette

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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About William De Vijlder

Group Chief
Economist
BNP Paribas
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