One of the key problems for the Euro is the loss of competitiveness of almost every country since the Euro was launched on 1st January 1999. Relative inflation rates since then suggest that prices in most countries are still higher relative to Germany than they were 15 years ago. This in turn implies that local inflation rates need to be lower relative to German inflation for a number of years in the future if the competitiveness issue is to be solved.
Germany’s latest inflation print was just 1.1%; so many countries would need to experience a prolonged period of falling prices to regain lost competitiveness within a reasonable period of time. This would require local wages/profit margins to fall and/or a significant increase in local investment in new ideas and techniques to raise output per hour worked.
Of course, if higher inflation rates can be engineered in Germany, competitiveness elsewhere in the zone might be rebuilt by freezing, rather than cutting, wages, prices, or margins, and without the need for as much local investment. But it is not obvious how to engineer higher inflation in Germany at a time when German growth appears to be slowing; also, it is unlikely that accelerating inflation in Germany would be a politically-acceptable or risk-free event.
This all suggests that the tough – possibly impossible – choices faced by Europe’s politicians show no sign of going away. It is therefore probably no coincidence that several times recently Mr Draghi made it very clear he thinks QE is possible, desirable and coming. If no one can or wants to pay for the things they consume, printing more money now seems to be the policy of choice for this generation of politicians and central bankers.
The balance of evidence all points to continuing uncertainty in 2015, with the hunt for income among savers putting pressure on yields to narrow between good and bad credits and bond issuers. More periods of volatility and more flights to quality may follow as politicians and the ECB come under increasing pressure to do something to try and restore confidence and growth. The onus will be on fund managers to pick the bonds that survive the inevitable bumps in the road.
|In a nutshell: Adam Cordery’s view on 2015:• Eurozone growth, inflation and unemployment to stay weak• Euro bond markets to continue to push back expectations of rate hikes, and (high-quality) bond yields in Europe to stay low• There to be growing influence on policymaking from newer political parties and movements• Politicians and the ECB to come under increasing pressure to do something to try and restore confidence and growth
• Speculation to grow about the ECB buying more and different types of bonds as part of a QE programme
• Investors to continue to hunt for yield, putting pressure on yields to narrow between good and bad credits and bond structures
• The fundamentals between the various euro corporate and sovereign issuers to continue to diverge
• Defaults, distress and restructurings to grow as a theme for both euro corporates and euro sovereigns
• More periods of volatility, more contagion and more flights to quality
Adam Cordery is global head of European Fixed Income at Santander Asset Management