William De Vijlder

Group Chief Economist BNP Paribas

10-year Bund yield back at zero percent. What are the drivers?

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Euro vs dollar

Monetary desynchronisation: a headache to come?

Monetary desynchronisation between the US and the Eurozone seems unavoidable due to a very different performance in terms of inflation. Whether this will complicate the ECB’s task of reaching its inflation target depends, in the short run, on the impact on financial conditions in the euro area. This influence will probably be small. In the medium run, when the US tightening cycle is well underway, US domestic demand growth will be slowing down, which will weigh on imports and hence Eurozone exports to the US. This would complicate matters for the ECB if by then, inflation has not yet reached its target.

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Banque centrale européenne

Eurozone: upside risks to inflation

Although they have eased recently, high Eurozone manufacturing price pressures are fuelling analysts’ concerns that inflation could stay high for longer. There is an impression that the ECB is increasingly sympathetic for this view. This is important in the run-up to the December meeting of the Governing Council. Whether supply bottlenecks and rising input prices will have a longer-lasting effect on inflation depends on the transmission to the rest of the economy. One would expect it to be higher under a combination of strong demand, low inventory levels and long supplier delivery times. This corresponds to the current situation in the sectors producing durable consumer goods, intermediate goods and investment goods. Perhaps, inflation could surprise to the upside after all in the near term.

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ECB: accommodation with no end in sight

The new macroeconomic projections of the ECB staff provide sobering reading for savers hoping that, one day, the policy rate will be raised. It is clear that at the current juncture, certain conditions of the recently updated forward guidance on interest rates states are not met. Based on the latest ECB projections, it seems this would still be the case in 2023, even under the hypothesis of a mild scenario. The slow increase of underlying inflation would probably be considered as unsatisfactory. Savers can only hope that the interaction between growth and inflation will evolve or that the ECB projections turn out to be too cautious.

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Illustration article Agefi septembre 2021

The apparent and hidden cost of States’ lack of fiscal space

The sharp increase in public sector debt due to the pandemic was an inevitable consequence of the automatic fiscal stabilizers, on account of their role. This was suitable and even essential, given the key role of government measures to support economic agents and boost demand. Yet, this increase raises the issue of the future orientation of fiscal policy.

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Fed adapts forward guidance, will ECB do the same?

In the early phase of QE, financial markets perceive central bank forward guidance on asset purchases and on policy rates to be closely linked. This generates a mutual reinforcement of both instruments. At a later stage, there may be mounting concern that the signalling works in the other direction as well. Scaling back asset purchases could be interpreted as a signal that a rate hike will follow soon once the net purchases have ended. In the US, Jerome Powell has been very clear that tapering would not signal a change in the outlook for the federal funds rate. In the Eurozone, both types of guidance are explicitly linked. This may complicate the scaling back of asset purchases in view of the impact on rate expectations. On the occasion of the decision on the PEPP, it might be worth to consider revisiting the link between APP guidance and rate guidance.

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Vitesse croissance

Growth hits speed limit

Judging by recent survey data, it seems many advanced economies are hitting against their speed limit in terms of economic growth. This has several consequences. It creates upside risks to inflation, something which is acknowledged by the Federal Reserve and the ECB. Labour shortages can cause faster wage growth but they should also underpin consumer confidence and spending. Supply bottlenecks should boost company investments. However, when growth is at the speed limit, future economic volatility may increase. Finally, it also creates an analytical challenge in understanding whether softer business surveys are demand or supply driven.

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Dollar engrenage

US inflation: increasing discomfort

Annual inflation has reached 5.3% in the US in June. Its drivers are still very concentrated but there is concern that they will spread. Anecdotal evidence is accumulating that price pressures faced by companies are increasing. Price pressures as reported in the ISM survey send the same signal. Historically, they have been highly correlated with producer price inflation and consumer price inflation but the transmission depends on factors such as pricing power, competitive position, labour market bottlenecks, etc. The next several months will be crucial for the Federal Reserve and for financial markets, considering the Fed’s conviction that the inflation increase should be temporary. The bond market has bought into this view thus far but, going forward, its sensitivity to upside surprises to inflation should be higher than normal.

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Loading 2021

A global macro economic analysis after 18 months of pandemic

A conjunction of developments has led in the first semester of the 2021 to a global improvement in business and consumer sentiment in advanced economies. Vaccination campaigns gathered speed while the number of new infections declined. Monetary policy support also played a part as well as fiscal policy. International trade and capital flows created international spillover effects which led to a sizeable improvement in the assessment of export orders.

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William De Vijlder

Outlook for the second half of the year: it’s not over

A combination of positive developments has led in the first half of the year to a broad-based improvement in business and consumer sentiment in advanced economies: successful vaccination campaigns, a declining number of new infections, ongoing policy support and positive international spillover effects. Gradually, the ‘mechanical’ recovery in sectors which previously had suffered from restrictions is expected to lose steam. Supply bottlenecks and certain price increases may end up acting as a headwind. The growth cycle, despite a gradual slowdown, is far from over but neither is the fight against Covid-19. There is increasing concern that new variants would lead to precautionary behaviour, thereby weighing on certain spending categories. This concern has already triggered a significant decline in bond yields, despite concerns that in the US inflation might stay higher for longer. It also means that central bank policy guidance will be a key point of attention in the second half of the year.

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US Treasuries: buyer beware

The significant decline of Treasury yields from their peak at the end of March is puzzling given the growth forecasts and the recent inflation data. This suggests that investors side with the Fed in thinking that inflation will decline. It also reflects the weakening of data in recent weeks, which implies that markets focus more on the change in the growth rate than on its level. The sensitivity of bond yields to economic data moves in cycles. One should expect that, as seen in the past, a less accommodative US monetary policy would increase this sensitivity because these data will shape expectations of more tightening or not. Before reaching that stage, we should already expect an increased sensitivity in the course of 2022, because it is quite likely that inflation will remain above the FOMC’s target.

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Looking beyond peak growth

The first half of the year has seen a broad-based improvement in business and consumer sentiment in advanced economies but elevated levels of business surveys reduce the likelihood of further significant increases. The third quarter is expected to see the peak in quarter-over-quarter GDP growth this year. Nevertheless, over the remainder of the forecast horizon –which runs until the end of next year- quarterly growth is expected to stay above potential. This favourable outlook for the real economy brings challenges for financial markets. Surprising to the upside in terms of earnings will become more difficult. Moreover, there is the question of the inflation outlook. For the time being, both the Federal Reserve and markets are relaxed about it but we should expect that over the coming months, the market sensitivity to growth and inflation data will be higher than normal in view of what they would imply for the Fed’s policy stance.

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Economic Growth

Eurozone: unemployment, consumer confidence and household spending

The labour market should play a crucial role in the recovery through its impact on household income and spending. There are reasons to be hopeful considering that recent business surveys show a further increase in hiring intentions whereas unemployment expectations of households have dropped below their pre-pandemic level. Household intentions to make major purchases over the next 12 months have already increased and this trend should continue on the back of an improved financial situation and reduced income uncertainty.

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ITW Bloomberg 28 June 2021

Delta variant and economic growth

William de Vijlder, BNP Paribas Chief Economis is interviewed by Anna Edwards and Mark Cudmore on “Bloomberg Markets: European Open” and discusses the delta variant issue and the outlook for economic growth.

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The (unwarranted) stagflation narrative of 2021

Strong US and Eurozone GDP growth in the second and third quarters should be followed by a gradual slowdown. Due to the ‘acquis de croissance’ going into the fourth quarter, the perceived slowdown versus the third quarter could be much bigger than what shows up in the current forecasts. In the US, the current elevated inflation will take time to decline. In conjunction with slowing growth, this could boost the stagflation narrative. Such a depiction of the economic environment seems unwarranted however, considering that inflation should decline further in the first half of next year and that the US economy should continue to grow above potential.  

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EcoTVWeek du 25/06

Is there a risk of stagflation? 

The 1970s have gone down in history as an era of stagflation, defined as a period of slow or even negative output growth and inflation that is high by historical standards. Two supply shocks in the oil market are considered as a key cause but other factors also played a role. In the course of this year, the lifting of restrictions related to Covid-19 has caused an imbalance between supply and demand, leading to a significant pickup in inflation. There is concern that growth, after being particularly strong, will slow, whereas inflation might stay elevated for longer. This has given rise to comments that stagflation, albeit in a lighter version, could make a comeback. However, this risk seems limited.

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Federal Reserve: enhanced credibility

More FOMC members than before are projecting a rate hike in 2022 and Jerome Powell made it clear during his press conference that tapering would happen when circumstances would justify this. Yet, 10 year Treasury yields, after an initial increase, ended up trading below the pre-FOMC meeting level. Break-even inflation also declined. Bond investors seem to share the view of the Fed that the current elevated inflation will be a transient phenomenon. This also explains the decline in the price of gold. The negative reaction of equity markets reflects an increase in the required risk premium and shows a certain unease about the impact of a less accommodative monetary policy on the growth outlook.

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Inflation higher for longer? The interplay between productivity, profit margins and pricing power

A complex interplay between unit labour costs, profit margins and pricing power will determine whether the current increase in inflation will be longer-lasting. Traditionally, in the early phase of a recovery, unit labour costs decline on the back of increased productivity. This should cushion the impact of higher input prices on profit margins. Subsequently, unit labour costs should increase but this does not imply that margins should decline. Given the strength of the growth acceleration, the fact that alternatives for meeting robust demand often do not exist and that going for market share makes no sense when faced with supply constraints, the conditions seem to be met for a rather significant transmission of higher input prices in producer output prices.

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Zone euro

Eurozone: peak growth momentum => peak in bond yields?

Historically, a very close correlation has been observed between cyclical peaks in German economic sentiment –which since the start of the euro more or less coincides with the peak in Eurozone economic sentiment- and the 10 year Bund yield. The latter tends to decline, once the peak in sentiment has been passed. Although other factors also play a role in the dynamics of long-term interest rates, the historical experience is important to keep in mind when assessing the outlook for bond yields.

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The ECB: under pressure

Judging by the recent data, the acronym PEPP that was introduced last year when the ECB launched its Pandemic Emergency Purchase Programme, could also be seen as a reference to the pandemic’s exceptional price pressures.  The upcoming governing council meeting and the new staff projections are eagerly awaited. Whether PEPP will be prolonged beyond March 2022 ultimately depends on the inflation data. It seems likely that the ECB will postpone its decision until after the summer in order to have a better view of the inflation outlook.

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Central bank inflation forecasts: ‘Trust us, we know better’

Strong belief in the quality of central bank economic forecasts enhances monetary transmission and hence the effectiveness of monetary policy. In the current environment of rising inflationary pressures, the belief of market participants that central banks have better forecasting skills should limit the rise in inflation expectations. Research casts doubt on whether such a belief is warranted. Although Fed staff projections tend to have lower forecast errors than private sector forecasts, the difference has narrowed since the 1990s. In the Eurozone, forecast errors for inflation of the Eurosystem/ECB staff projections were equal to those of the Survey of Professional Forecasters.

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About William De Vijlder

Group Chief
BNP Paribas
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