Room For Additional Economic Stimulus Continues To Shrink, Stock Market Trend

Most analysts view the current correction on stock markets worldwide as unavoidable. Tensions in Europe linked to the public finances are on the rise, China is trying to restrict domestic credit supply, and the Fed faces a torrent of criticism at home and abroad regarding its policy to increase quantitative easing by $600bn with an option to draw down more. It is feared that further quantitative easing would only weaken the dollar further and push up commodity prices. As a result of the latter the rapidly growing Asian economies would come under additional inflationary pressures.

European short-term interest rates and bond yields – Eurozone: One monetary union, very different economies

Owing to fiscal tightening in the eurozone we expect decelerating economic growth for the time being. The – temporary – bail-out of Ireland does not change a thing. Both Ireland and the eurozone are still facing the same problems. As the situation in the weak euro countries is quite desperate, long-term interest rates in these member states will likely continue to rise. Simultaneously, the spread between bond yields in the weak and the strong euro states could widen in the coming months. On top of this, the 3-month EURIBOR may be expected to rise in the coming period, whereas the EUR swap spread could continue to widen. The main reasons are slowing economic growth, mounting uncertainty on the financial markets, and fresh banking woes. The 3-month EURIBOR may climb from around 1.04% towards 1.50% as the EUR swap spread widens from near 30 bp to around 50 bp. In the coming months the German 10-year yield (now around 2.7%) could on balance rise towards 3% in the wake of rising US bond yields. Subsequently, it may fall quite sharply.

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European short-term interest rates and bond yields – ECB is standing firm …for now

The ECB is pursuing a considerably more restrictve monetary policy than the Fed. In our view the trouble in the euro area will grow worse over the coming period. This could widen the spreads between bond yields in the weak and the strong euro countries. The 3-month EURIBOR may well rise from near 1.05% towards 1.5% in the coming months as the EUR swap spread widens from 32 towards 50 basis points. In the near future, the German 10-year yield (now around 2.4%) may drop slightly due to the flight to safety as a result of mounting problems in the struggling euro states.

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