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Some weeks (and these are normally the good weeks for markets) I am scratching round for things to write here. This is not one of those weeks. There is so much going on that a shortish weekly note just won’t do it justice. Next week I will write our usual quarterly overview and outlook piece that will try and cover it all and which we will e-mail round in this slot. But, today, I will write about Europe and what looks like it might be the start of another Eurozone debt crisis.
Here is the increase in 10-year government bond yields over the last year:
One simple story is that the war in Iran has pushed inflation higher and the AI investment boom has pushed US growth higher. One long-term anchor for 10-year government debt yields is that they should (roughly) be close to the nominal growth rate (i.e. inflation + real growth) for that country. Below is the recent nominal GDP growth for the US. One more positive story for the rise in US interest rates is that they are just rising higher in response to higher nominal growth. Today’s 10-year yield is 5.2%, which is not far off the recent US growth rates you see here:
I am leading with the more positive explanation because it explains why equity markets, and especially US equity markets, have so far been relatively nonplussed by the higher move in rates. There are other more bearish explanations of course to do with overall US government solvency worries. But if this was happening, I am not sure US equity markets would be so sanguine. US futures are up this morning as I type even after a tough day yesterday in Europe.
But, and here is the real problem I think, the move in the US is pushing up yields for everyone. And this does bring some real solvency risks into play. My first chart shows it is the most heavily indebted non-US countries with the highest deficits that are getting punished the most. So, step forward France (with Portugal, Italy, Greece and Spain – the PIGS of the last Eurozone crisis – not far behind). The Eurozone countries have, of course, the added problem that (unlike the US and UK) they cannot simply print money to repay the debt. That responsibility lies with the ECB. On paper, France does not look that different to the US. But lower growth and the fact that it is not borrowing in its own currency mean it is under much more pressure.
Ultimately, this will force some form of austerity (higher taxes and/or lower spending) on Europe. How severe this is and how much is done via higher taxes remains to be seen. But I think yesterday’s fall in European equity markets (while the US stayed steady) reflected some of that risk.
I have written here before that if you are worried about an AI investment boom and bust then boring old Europe, with its traditional but profitable businesses, looks like a decent hedge. Well, today, if you are worried about France going the way of Greece and Italy in 2011, then US equity markets and all things AI might offer some much-needed diversification.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
