The European Central Bank (ECB) recently raised interest rates to 4%, a decision that I believe was a policy mistake. The European economy is already facing significant challenges, and the ECB’s decision to tighten monetary policy is only making things worse. One reason for this is that Europe’s private sector has been enjoying low borrowing rates for quite some time, which makes policy changes more difficult.
A graph displaying European BBB’s 10-year corporate borrowing costs from 2013 to the present supports this point. From 2013 to 2023, the average borrowing cost was 1.69% (blue line), while from 2016 to 2019, it was only 1.35% (green line). However, currently, borrowing costs have skyrocketed to 4.20%, nearly tripling in comparison to previous years. This significant tightening of borrowing conditions has had a detrimental impact on the European economy.
In addition to the negative effects of the ECB’s rate hikes, there is another significant concern for Europe: a refinancing cliff. The graph shows the percentage of corporate loans and bonds maturing each year by different jurisdictions. European companies are facing a challenging period as they will need to refinance 25% of their borrowing needs in 2024, with higher borrowing rates than the current ones. This poses a serious threat to the European economy.
Turning to Japan, the country plays a vital role in global bond markets. As one of the largest capital exporters, Japanese investors are considerable buyers of U.S. Treasuries, European bonds, and other foreign bond markets. However, the Bank of Japan recently hinted that its era of negative interest rates may soon be coming to an end. This statement caused currency and bond markets to rise.
The reason Japan’s actions are crucial for global bond markets is because Japanese investors have accumulated savings and foreign exchange reserves, and they seek higher returns by investing these assets overseas. The support from Japanese investors has been diminishing in recent quarters, and the potential rise in domestic yields may further reduce their investment in foreign bonds.
Shifting to the United States, August saw a concerning acceleration in inflation. The Fed analyzes core CPI by dividing it into goods inflation, housing inflation, and services excluding housing inflation. Disinflationary forces are primarily affecting goods, as excess inventories and supply chain issues continue to suppress core goods prices.
On the other hand, housing inflation, which comprises a significant portion of the core CPI basket, has shown signs of deceleration. Shelter rents have gradually slowed down, as reflected in rent growth observed on platforms like Zillow. This trend is positive news for the Fed.
Core services excluding housing is an important measure of inflation for Fed Chair Jerome Powell. While the monthly result was stronger than expected, further analysis demonstrates a downward trend in inflation. The six-month annualized percentage change reached a new low this cycle, signaling that persistent inflation is becoming more manageable.
Overall, it appears that the Federal Reserve is done with raising rates. However, some factors like rising oil prices, pressure in the bond market, and strong performance in core services excluding housing are raising questions in the market. There may be uncertainties on the horizon, signaling a potential macroeconomic storm.