Relative Speed

Key points

  • Accumulating signs of cyclical softness in the US may help Biden’s massive stimulus through Congress, but some compromise will be needed. Powell has nipped in the bud suggestions of an early taper, but we think US long-term interest rates can still rise further. Europe meanwhile is enjoying “positive contagion” from the US: inflation expectations are up, but nominal yields barely moved, and equity is performing well.

Some very tentative signs of progress are emerging on the pandemic front in the Western countries. Lockdowns still work. However, the timing of the re-opening of the economy still depends on the relative speed of the virus propagation and of the vaccination programme. The UK perfectly exemplifies this. While inoculations are happening faster there than in any comparable country, a significant acceleration is still needed to reach the target of covering the most vulnerable segments of the population by mid-February, which the prevalence of a more contagious variant is making even more urgent. In continental Europe, the vaccination programme has not yet really taken off.  We maintain our baseline that full normalization should not be expected before this summer.
Some Euro area countries such as Germany and Spain may have (just) avoided another contraction in GDP in Q4, but Q1 looks grim given the intensification in mobility restrictions. In the US, indications of labour market softness are accumulating, with a significant dampening impact on private consumption. This may help Joe Biden get his fiscal package through congress with some bi-partisan support, but we think the massive USD 1.9trn top up to the 0.9trn already agreed is an opening gambit by the incoming administration: necessary compromises will probably shrink the package. Yet, we still think a stimulus of c.10% of GDP this year is likely.
Jay Powell sought to nip in the bud speculations over a quicker than expected taper which would be justified by the stronger fiscal stimulus, but we reiterate our view: merely reassuring on the continuation of the current stance will not suffice to stop the rise in US long-term interest rates. However, Europe seems to benefit from “positive contagion” from the US. Inflation expectations have rebounded in Europe as well, but nominal yields have barely moved. The European equity market outperformed the US. ECB’s Schnabel “pre-emptively dovish” interview last week may have helped. We expect similar comments from Christine Lagarde this week after the Governing Council meeting.
The ECB is probably monitoring very closely Italian politics. A “de facto” confidence vote in the government will take place on Tuesday in the Senate. Early elections remain unlikely at this stage, which probably explains the market’s restrained reaction. The election of Armin Laschet as leader of the CDU, suggesting continuity with Angela Merkel’s European stance, may help keep the peace on the Euro area’s bond market.

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