Alpha Bank: The factors that will determine the course of bonds

The ECB’s interest rate policy will have a catalytic effect on the short-term trend of bond yields, but in the medium to long term it will be the performance of each country that will determine the course, according to Alpha Bank’s Financial Studies Directorate.

In particular, according to the bank’s weekly Bulletin of Economic Development, since the outbreak of the pandemic, the expansionary monetary policy pursued by the main central banks, through the reduction of interest rates and the implementation of quantitative easing programs, has squeezed the financing conditions of fiscal support packages for their economies at very low cost.

However, recovering demand and supply disruptions have led to a sharp rise in inflation. As a result, interest rates were raised by the main central banks in order to ease inflationary pressures, which contributed to the upward trend in bond yields.

The yield on the 10-year US government bond reportedly exceeded 2% on February 10, for the first time since August 2019, in the wake of the announcement of US inflation at 7.5% in January. , which is the largest annual increase since 1982.

In both Greece and Italy and Germany there has been a parallel increase in 10-year bond yields in recent years as well as a slight widening of the spread of 10-year bond yields in the South in relation to the German bond, a development reflecting the highest debt-to-GDP ratio (2020: Greece 206.3%, Italy 155.6% versus 68.7% of Germany).

However, the main factor behind the rise in bond yields is common to all countries and is related on the one hand to the concerns of the international investing public about the possible start of a war on the border between Russia and Ukraine and on the other hand to the fact that the ECB does not excludes an increase in interest rates within the year, in order to mitigate inflationary pressures, if they prevail for a longer period than originally expected.

On the other hand, investment inflow expectations and boosted savings maintain the high performance of the Economic Climate Index in the country at the beginning of the year, despite the worryingly rising trend in energy prices internationally and rising inflation expectations.

In particular, the Recovery and Resilience Fund is expected to provide a significant impetus to achieving high rates of economic growth in the coming years and the accumulation of savings during the pandemic, can finance a strong consumer spending, as well as small investment projects involving small small and medium enterprises.

More specifically, the Economic Climate Index has largely offset the losses it suffered during the pandemic, as a result of measures to curb and cess economic activity. According to the data recently published by the European Commission, the Economic Sentiment Indicator (ESI) in Greece stood at 114.2 points, in January 2022, against 110 points, in December 2021 and 90.6 points, in January 2021.

This is the highest recorded performance of the index, not only since the onset of the pandemic crisis, but in the last twenty years, as the next highest value recorded was in December 2000, at 116 points.

Of the sub-indices of business expectations that make up the ESI index, the biggest improvement in January 2022, compared to the previous month, was recorded by industry (13.2 from 7.5 points), followed by services (39.4 (37.5 points) and consumer confidence, which although has recovered to some extent since November 2020 – the month with the lowest price since the outbreak of the pandemic crisis (-48.3 points) – remains at a fairly low level (-42.2 from -43.2 points). On the contrary, the indicators of business expectations in the retail trade and constructions marked a significant drop, as the first from 19.2 points fell to 11.3, while the second from -7 points reached -14.8 points.

ECB monetary policy and returns

The European Central Bank (ECB) ‘s response to the pandemic crisis has been crucial, ensuring a smooth flow of funding to the Eurozone. The announcement of a Pandemic Emergency Purchase Program (PEPP) totaling € 750 billion in March 2020 catalyzed the rapid de-escalation of bond yields, which were moving upwards due to uncertainty. caused by the pandemic.

The strengthening of PEPP by Euro 600 billion and Euro 500 billion, in June and December 2020, respectively, gradually pushed government bond yields to historically low levels, despite successive lockdowns that burdened economic activity.

Late last summer, after which inflationary pressures intensified, the trend was reversed as bond yields began to rise. The ECB, following a different approach compared to other major central banks such as the US Federal Reserve and the Bank of England, did not expect interest rates to rise in 2022.

At the December 2021 meeting, however, it was decided to end the PEPP bond markets in March 2022. This development, combined with the fact that the head of the ECB at the last meeting (3 February) did not rule out the possibility to finally raise interest rates within the year, accelerated the rise in bond yields in the Eurozone. In Greece, the interest rate curve on February 14 has shifted upwards compared to December 31.

It is worth noting that the rise in yields is reflected in the volume of bonds worldwide, which offer negative yields, which has fallen from 18.4 trillion. dollars, in December 2020, at 4.4 trillion. dollars (14.2.2022), recording a rapid decrease from the last ten days of December last year. In advanced economies, negative returns are now recorded only on two- and three-year bonds.

Factors that will determine the course of bond yields

The ECB’s interest rate policy will have a catalytic effect on the short-term course of bond yields. Tackling inflation is a crucial issue, the intensity and duration of which may be the factors that will determine whether there will be an increase in interest rates in 2022.

In addition, a very important factor that could change the plans, which was also raised by the head of the ECB at the last meeting, is the geopolitical and especially the tensions between Russia and Ukraine. A possible escalation of tensions would lead, inter alia, to further increases in energy prices and consequently inflation, intensifying pressure on the ECB to raise interest rates.

It is noted that, in December 2021, inflation in the Eurozone stood at 5% on an annual basis, with about half of the increase attributed to rising energy prices, despite their relatively small share (9.5%) in shaping it. Harmonized Index of Consumer Prices. However, in the medium to long term, each country’s macroeconomic performance, such as fiscal stability and satisfactory economic growth rates, will determine the course of bond yields.