Investors Are Increasingly Reluctant To Buy US Treasuries Even At These Yields

By Bas van Geffen, Senior Macro Strategist at Rabobank

Yesterday, my colleague wrote that not everything is worth worrying about equally. Financial stability reports always provide plenty of fodder for pessimists; after all, the purpose of these reports is to raise awareness of potential downsides. But not all risks are equally concrete or urgent. Having said that, in its latest Financial Stability Review, the ECB was more blunt about financial risks than in previous years.

The central bank is particularly worried about the potential resurgence of the sovereign debt crisis, but unlike the original crisis, France is now being called out as a particular risk: “policy uncertainty [or paralysis], weak fiscal fundamentals in some countries and sluggish potential growth raise concerns about sovereign debt sustainability.” Countries’ debt ratios are high, and this debt increasingly has to be refinanced at higher interest rates. Admittedly, it is somewhat alarming that fiscal metrics haven’t recovered since the pandemic – although ratios have improved over the past few years.

The ECB continues that “large primary deficits make it harder to provide additional investment to combat structural challenges, including climate change, defence spending, and low productivity.” It’s hard to argue with this logic. Yet, at the same time, the bold investments required to fix Europe’s low structural growth rate require big government outlays. And, as we’ve noted almost a year ago now, any government will find it hard to gather voters’ support for structural investments and reforms if this means cutting back on social spending.

Corporate actions only underscore this need for structural improvement: yesterday, Ford announced it would cut 4,000 European jobs due to sluggish demand for electric vehicles and “fierce competition from China.”

At the same time, the outspokenness of the ECB’s Financial Stability Review is perhaps something of a warning to those who are banking on steep rate cuts. Of course, if a crisis were to develop, the ECB may have no other choice but to go back to it’s playbook for most of the 2010s. But the concerns about refinancing risk and higher interest costs imply that the central bank does not anticipate a return to very low rates.

Likewise, incoming data underscore that the easing cycle may not be as fast as some expect, and that it may end at a substantially higher rate. Yesterday, the ECB reported that Eurozone negotiated wages rose 5.4% y/y in Q3, pouring a bucket of cold water over any remaining expectations that the central bank may cut by more than 25 basis points in December. A rebound had been expected after the 3.5% print in the second quarter but the re-acceleration was significantly stronger than both we and the ECB had anticipated.

A large part of the acceleration can be attributed to strong wage increases in Germany. In Q3, collective agreements led to an 8.8% y/y increase in German wages. Stripping out one-off payments, German wages clocked in at 5.7%; That’s a sharp acceleration from 4% in Q2. We don’t believe that this acceleration will be sustained. The recent IG Metall deal, for example, suggests more moderate wage growth in the coming quarters. Nonetheless, data continue to underscore that wage pressures are receding only gradually.

Relatively sticky wages in other countries are also pointing in that direction. Dutch employers’ association AWVN tracked collectively agreed wages in Q3 at 4.3%, while Italian and Spanish wages appear to have stabilized just above the 3%-mark. On the very other end of the spectrum, French wages are still trending down, from 2.8% in Q2 to 2.7%. This will likely converge to further to the inflation rate in the coming quarters.

So, all in all, these data should not prevent the ECB from another 25bp cut in December, but they do underscore the need for caution as the ECB navigates heightened uncertainty about growth and lingering inflation risks.

Many of these risks are ultimately of Europe’s own making, but incoming President Trump is putting them in the spotlight. Trump has been quick to assemble much of his team, but one of the key roles, Treasury Secretary, remains unfilled for now. The President-elect’s more cautious approach perhaps reflects his awareness of the importance of this position. The FT reported yesterday that Marc Rowan –who is not unfamiliar to Wall Street–  is now a top contender for the job.

And Trump is right to consider his options. Because whoever gets the job, it will be a tough one. The incoming Treasury Secretary will have the difficult challenge of uniting Trump’s agenda of disruption and change in the (world) economy, and tax cuts, with stability in financial markets. The potential impact on the US fiscal deficit is getting increasing attention, and yesterday’s auction of 20y Treasury bonds served as a warning to the incoming administration. The auction drew very weak demand, even though 20y yields have risen from 4% in mid-September to around 4.65% currently. Although the 20 year is admittedly a bit of an odd point on the US curve, it does suggest that investors are reluctant to buy Treasuries even at these yields as long as there are concerns about potential impact of Trump’s plans on the deficit.