Alfonso Peccatiello1 critiques the European Central Bank's (ECB) decision to raise interest rates to 4%, terming it a "policy mistake." One reason he outlines is the rapid and acute tightening European companies are experiencing compared to their U.S. counterparts. According to Peccatiello, this difference can be attributed to the ECB's stricter policies and the long-standing luxury of low borrowing rates enjoyed by the European private sector.
Europe's Policy Blunder
To illustrate this, Peccatiello shares data on European BBB 10-year corporate borrowing costs from 2013 onwards:
- Between 2013-2023, the average was 1.69%.
- For 2016-2019, the average reduced to 1.35%.
- Currently, the rate has shot up to 4.20% and has been stagnant at this figure for nearly a year.
European companies now face the challenge of much higher borrowing costs. Additionally, they must also navigate the looming "refinancing cliffs," where companies need to refinance a significant portion of their borrowing needs at these increased rates. Peccatiello's data shows that European firms will have to refinance about 25% of their borrowings in 2024 at these escalated rates. This dire situation might force companies to reduce leverage, downsize, or even cut jobs to remain operational.
Peccatiello asserts, "The ECB just hiked in the face of an already weak economy facing sizeable refinancing cliffs: I think Lagarde just made a policy mistake."
Japan's Influence on Global Bond Markets
Peccatiello discusses the end of Japan's negative interest rate era, as indicated by the Bank of Japan governor Ueda. The question arises: why is Japan crucial for global bond markets?
Japan stands as one of the largest capital exporters globally. Japanese investors have invested massively in U.S. Treasuries and European fixed incomes. As Peccatiello notes, "Japanese investors alone own over $1 trillion of US Treasuries and some EUR 400 bn in various European bonds."
Yet, a rising domestic yield in Japan could impact foreign investments. Despite the potential increase in domestic yields, Japanese support for global bond markets has already started to wane. This can be attributed to the high foreign exchange hedging costs, making U.S. Treasuries notably costly for Japanese investors. Peccatiello observes that U.S. Treasuries are "the most expensive in decades for Japanese investors." The upcoming actions of the Bank of Japan will be instrumental in deciding the continuation of this trend.
Is the Fed Done with Rate Hikes?
In light of recent data showing accelerated U.S. inflation in August, Peccatiello explores the implications for the Federal Reserve (Fed). He highlights that the Fed examines core CPI (Consumer Price Index) through three lenses:
- Goods inflation
- Housing inflation
- Services excluding housing inflation
Recent data seems favorable for the Fed:
Goods inflation is showing signs of moderation.
- The housing inflation rate has reduced from a peak of nearly 10% earlier this year to a 3-month annualized rate of 4.6%.
- The sticky inflation metric, closely watched by the Fed Chair Powell, displayed a 0.4% month-over-month increase, but its 6-month annualized rate has dropped to 2.7% from over 5% at the year's start.
- Peccatiello concludes that while indications suggest the Fed might have ceased hiking rates, challenges like rising oil prices and bond market pressures could force a reconsideration.
In summary, economic conditions across continents display signs of volatility. From ECB's controversial decisions to changing dynamics in global bond markets due to Japan, to the U.S. Fed's future moves, there seems to be a brewing "macro storm," as Peccatiello aptly describes.
Footnote
1 Adapted from source: (Alf), Alfonso Peccatiello. "The Key Macro Charts To Watch." The Macro Compass, 17 Sept. 2023, themacrocompass.substack.com/p/the-key-macro-charts-to-watch
