IT'S A DEFLATIONARY EPOCH:

Since mid-May, eurozone long-term interest rates have plummeted. In Germany, the entire yield curve--interest rates across the range of German government bond maturities--is below zero out to 30 years. This is occurring as eurozone (and German) economic growth has accelerated. Is there a disconnect--a cause for concern--as some coverage suggests? We don't think so. Let us explain.

The recent move is largely a reversal of volatility earlier this year, when so many thought reopening would juice economic growth and inflation for a long time to come. Bond yields' rise was global, dubbed the "reflation trade." Long-term eurozone yields climbed into positive territory in February as vaccinations ramped up and countries began reopening.[i] Deflation late last year turned into inflation this year with the headline rate speeding to 2.0% y/y in May (finally hitting the ECB's target after years below it).[ii] Pundits saw this as just the tip of the iceberg, warning supply constraints and rising raw materials prices would make prices soar and stay there. Eurozone GDP has since accelerated to 2.0% q/q growth (8.3% annualized) in Q2 from Q1's -0.3%, with economists presently projecting 2.4% growth in Q3.[iii] Q2 GDP stands -3.0% below its late-2019 peak, so a couple more quarters of rapid catch-up growth could lie ahead.[iv]

But after the rebound back to pre-pandemic GDP levels, more pedestrian pre-pandemic growth rates should follow. 

Tweet   @brothersjudd