As U.S. debt levels soar, euro zone bonds act as alternative
Worsening government finances, a fragile currency, rising interest rates and heightened political uncertainty? U.S. Treasury bonds’ status as the world’s ‘risk-free’ asset looks shaky and euro zone debt may offer an alternative. Global investors looking to minimize risk — particularly those in Europe — have been steering clear of U.S. Treasuries in recent months, even while the interest rate gap between the United States and Europe has ballooned further. U.S. debt levels, expressed as a percentage of gross domestic product, are on track to rise above those of Italy — long one of the world’s most indebted states — in five years, the International Monetary Fund warned last month. With some $1.5 trillion in tax cuts and $300 billion in new spending planned by the Trump administration, the U.S. fiscal deficit is expected to widen sharply, possibly topping $800 billion next year, up from $665 billion in 2017. And as the Federal Reserve’s balance sheet shrinks, rising supply of new bonds and higher interest rates risk making the U.S. government bond market more volatile. In the euro zone, by contrast, debt levels and bond issuance are falling steadily, and once crisis-hit states such as Spain and Portugal are enjoying credit ratings upgrades. Ebbing existential threats to the euro, steady economic growth and continued low borrowing costs are luring more foreign buyers to European bonds — year-to-date inflows are around $15 billion versus a fall of around $4 billion a year ago, according to EPFR Global data. Japanese investors bought a record $2.57 billion of Spanish bonds in March. “The world still needs havens, and if U.S. Treasuries are not doing what they say on the tin, the world will look for alternatives, and that plays into euro debt having a better ‘haven’ status,” said Barnaby Martin, credit strategist at Bank of America Merrill Lynch (BAML). “For reasons of depth and liquidity, you still won’t be able to beat the U.S. Treasury market but it’s not the haven that it used to be.”
Euro stuck near four-month low as U.S. bond yield rise supports dollar
The euro remained stuck near four-month lows on Tuesday after weaker-than-expected economic growth in Germany and a rise in U.S. Treasury yields helped the dollar recover following a pause in its rally. The dollar’s strength also helped it gain to within a whisker of hitting a 3-1/2 month high versus the Japanese yen while major currencies elsewhere traded within tight ranges ahead of U.S. retail sales. The greenback’s rally, which has seen the dollar claw back most of its 2018 losses after a reassessment of the path of U.S. monetary policy versus other countries, came to a halt last week following disappointing U.S. inflation numbers. Euro bulls were also given a boost on Monday after European Central Bank policymaker Francois Villeroy de Galhau said that the ECB could give fresh guidance on the timing of its first rate hike as the end of its exceptional bond purchases approaches. “After the U.S. CPI (consumer price inflation) data the dollar’s momentum has fallen off,” said Alvin Tan, an FX strategist at Societe Generale. “For our view to be validated, that euro/dollar will move higher, we will need to see European data pick up again. Data is going to be important in the near term.” German economic growth slowed slightly more than expected in the first quarter of the year due to weak trade but analysts called it a blip and predicted Europe’s biggest economy would shift into a higher gear again. A survey showed that the mood among German investors remained unchanged at its lowest level in five and a half years in May, reflecting persisting concerns that Europe’s biggest economy could be hit be a trade dispute with the United States.
EU seeks better U.S. trade ties, but not as tariff concession
The European Union is interested in improving its trade ties with the United States but it will not make concessions to secure an exemption from U.S. metals tariffs and would need to consult its 28 members, a senior EU official said on Tuesday. “We are open for improving our trade relations… but it’s not a concession in order to get a permanent exemption from higher steel and aluminium tariffs,” Commission Vice-President Jyrki Katainen told a news conference. Washington has been granted the EU a temporary exemption from import tariffs on steel and aluminium until June 1. “There’s no reason for those tariffs… It wouldn’t be logical to give up under pressure that is unjustified. We don’t negotiate under any kind of threat,” Katainen said. He said that the EU remained interested in improving trade relations with the U.S. but “before entering any kind of negotiations, if it ever happens, we have to get support from the EU member states and that’s another question,” he told a news conference.
Soft China April investment, retail sales suggest economy losing steam
China reported weaker-than-expected investment and retail sales in April and a drop in home sales, clouding its economic outlook even as policymakers try to navigate debt risks and defuse a heated trade row with the United States. Fixed asset investment grew the slowest since 1999 while the pace of retail sales softened to a four-month low, suggesting a long-anticipated slowdown in the world’s second-largest economy may finally be setting in even as protectionism is on the rise. The lone bright spot on Tuesday’s activity data was industrial output, which jumped more than expected as automobile and steel production surged. “Industrial activity was buoyed by the easing of pollution controls (imposed over the winter). But there are signs in the rest of today’s data that the economy is losing momentum,” Capital Economics senior China Economist Julian Evans-Pritchard wrote in a note following the data. “Domestic spending is likely to continue to soften given the headwinds from slowing credit creation,” he said, adding that the rebound in industry may be short-lived once companies rebuild inventories which were depleted in recent months. Capital Economics has long predicted Beijing will loosen monetary policy later this year to keep growth from slowing too sharply as it continues a crackdown on financial risks. Industrial output rose 7.0 percent in April, the National Bureau of Statistics said, beating forecasts for a rise of 6.3 percent and up from a seven-month low of 6.0 percent in March.