Economic improvement reaching Europe - BNPP

Laurence Mutkin, Research Analyst at BNP Paribas, explains that Euro area economic recovery is beginning as the euro area economy is following the US economy into a genuine (if unexciting) recovery.

Key Quotes

“This is typical of what happens at the beginning of the growth cycle.

• Eurozone unemployment is falling towards the NAIRU, lagging the US by about two and a half years.
• The Eurozone output gap is closing, lagging the US by about one year.
• Eurozone core CPI is expected to accelerate from current levels, lagging the US by about eight months. 
• Overall, nominal GDP in the Eurozone has followed the US upwards since the ECB followed the Fed into quantitative easing (QE); the lag has been about three months over the long term.”

“European yields have been rising with US yields, ahead of the improvement in EU data. This is also typical of this stage in the growth cycle because financial markets can be forward-looking in a way than economic indicators cannot be.”

“The time in the cycle is approaching where EU yields underperform US, but it’s probably too early to position for that yet, because: (1) the US-EU spread typically does not narrow until the pace of US yield increases moderates; (2) long US versus EU has negative carry in intermediate and longer maturities; and (3) the ECB is expected to continue to suppress yields via QE and forward guidance for several more quarters.”

“Better is to benefit from the positive roll of EU forward flatteners vs US steepeners: the 10-year US-EU spread is – perhaps surprisingly – positively correlated with the 2s10s box, because the front ends of the curves are more volatile than the back ends. With its 2.2bp/mth positive roll, we continue to favour 1y forward 2s10s flattener in EU vs steepeners in US.”