Fed rate hike: for BTP and Bund record yields, the stock exchanges are running. What Happens Now?

Rates rising, inflation skyrocketing. What happens?

What’s going on? The clear answer. The US central bank, and soon probably also the ECB, are forced to act in the face of alarming trend inflation data. That in April The data are eloquent. The latest inflation figures for April indicate a trend increase in the cost of living of 7.5 for the eurozone. In December we were around 3%. In the United States, which sets the monetary policy of the main central banks in motion, the situation is even worse. In April, the price rush reached 8.5%, a record since 1981. In terms of economic growth, the International Monetary Fund has just released its spring forecasts. Given the war between Russia and Ukraine, the bottlenecks in supply chains and the more restrictive policies currently being adopted by central banks, global growth should settle at 3.6%, -0.8% compared to previous indications . For Italy the most full-bodied cut, with a reduction of 1.5%. According to the IMF, the tricolor economy will grow by 2.3% (against the 3.1% estimated by the government in the Def). There are downside risks across the eurozone, but a recession is not expected.

What to do at the ECB: the hawks are flying again

In this scenario of greater fragility, the hawks fly again. On 20 April, Joachim Nage, the new governor of the Bundesbank, the German central bank, expressed the hope that the ECB will decide on an interest rate hike already in the third quarter of 2022. Up to now, Frankfurt has been cautious and has shown that it does not want to follow the Fed in a flurry of cost of money hikes that everyone on Wall Street takes for granted. The ECB wants to proceed step by step and Christine Lagarde limited herself to predicting the end of the purchases of securities by the ECB by the end of the third quarter. The (official) rates will go up later.

But the markets have already spoken

However, the market is not waiting and has already reacted to the new context of inflation and lower growth. I am in fact cyields on government bonds significantly increased: the 10-year Bund, which stood at -0.18% at the beginning of the year, reached a positive yield of 1% (German government bonds are now out of the limbo of negative rates for all maturities) while the Italian BTP in a few months ago it even more than doubled its coupon, reaching almost 3%. A value not unlike that of the US Treasury, at 2.78%, the highest since December 2018. With government bonds, mortgages and corporate loan rates are also rising. In a few weeks, the 20-year Eurirs rate, used to determine the rate of fixed-rate loans, rose from 0.85% to 1.3%

Risks for families and businesses

For now, this is a modest deterioration, but households and businesses are starting to pay a price. The installments of the new fixed-rate mortgages are more expensive than a few tens of euros (the exact amount depends on the amount borrowed and the maturity of the loan) while those who have a variable-rate mortgage are already affected by the increase of a few euros in the installment, given that the short-term Euribor rates on which the variable rate mortgages are based are also up by a few hundredths of a point. But the real unknown for the state accounts. The spread has started to move again and has stably exceeded the threshold of a BTP – Bund yield differential of 190 cents of a point. In the morning of 5 May it reached 195 points. If monetary policy were to suddenly become restrictive and the conditions of the European and global economy worsen significantly, are there any risks of a return to the sovereign debt crisis?

Europe and the USA: divergent choices

For the moment this hypothesis seems distant. To begin with, the dynamics of interest rate hikes in the United States and Europe are very different. In the US, 6 rate hikes are expected that could bring the cost of money in the countries to around 3%, from the current or, 75-1% over 12-18 months. Core inflation not linked to energy and commodity prices in the US is in fact very high and exceeds 5%. In the Eurozone, where the core inflation rate of around 3% does not exist this urgency and the ECB first wants to proceed with the end of the App securities purchase program (Asset Purchase Program).

The ECB shield

And if future increases – gradual, as the leaders of the ECB and Christine Lagarde continue to insist – should determine such shocks on spreads as to modify the transmission of the impulses of the monetary economy, the ECB is ready to intervene. Frankfurt’s plans are not yet known in detail but it is known that the ECB is developing a sort of anti-spread shield that would have the effect of reducing the yield differentials between the issues of individual states at a time of contraction of the monetary policy. These would probably be targeted purchases of securities which, however, have yet to be defined in their technical and legal form.

Resources available

For the moment, the economic situation of companies is worsening but not unsustainable. According to Bloomberg, the operating conditions of companies have eroded, going from +0.70 in February to -0.25 in March (latest data available), mainly due to the Russian-Ukrainian war. And at the same time the state accounts, despite a marginal increase in the cost of servicing the public debt, show a good resilience. The 100 billion euro requirement that the MEF forecast for 2022 was reduced to 89 billion. Basically, there would be a small treasure available to carry out that expansive fiscal policy maneuver that many invoked to counter the slowdown in GDP growth. And the aid decree launched a few days ago by the Draghi government for an amount of 14 billion – without increasing the public debt – goes in this direction.

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Fed rate hike: for BTP and Bund record yields, the stock exchanges are running. What Happens Now?

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