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Capital Markets

Bond Outlook by bridport & cie, April 6 2011

The US economy is recovering, but only because of cheap money. In contrast, Europe appears to on a path to normalisation of bond markets and central bank policy.

The parting of the ways between the USA and Europe on military matters (the USA stepping back from a leadership role in NATO over Libya) has parallels with each region’s economic policies:

 

  • in the USA, the recovery, whilst real enough in terms of corporate profits and employment, is dependent on cheap money and quantitative easing
  • in Europe, despite the peripheral problems, a move towards normalisation in financial markets, especially for sovereign and bank bonds, is underway, with the ECB expected to increase interest rates as we write

 

The EUR is strengthening whilst the USD weakens. Yet inflation in the euro zone is higher (2.6%) than in the USA (1.6%). That is if we are to believe the official data; MIT, by contrast, puts the US inflation rate at 8.5%. The ECB accepts that it must raise rates, while the Fed fears that it cannot do so without damaging the recovery. This points to the euro zone returning to normal in terms of central bank policy. Moreover, it supports the view that Germany and the other strong economies in the euro zone are succeeding in coping with their weaker brethren.

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