'Euroglut' could keep yields low for rest of decade

Europe has become the world’s biggest saver, not by choice but because of the sovereign debt crisis that caused a collapse in domestic demand. The elevated unemployment rate and the debt-deleveraging cycle have suppressed domestic consumption. The lack of consumption, in turn, reversed current account deficits into huge surpluses. At US$300 billion per year, the euro zone’s current account surplus is currently 50 per cent larger than China’s. 

A surplus on the current account implies capital outflows elsewhere. Deutsche Bank expects Europe’s huge excess savings combined with aggressive monetary easing by the European Central Bank will lead to one of the largest capital outflows in the history of financial markets. Investment implications are as follow. 

 

1. Euro weakness: As capital flees Europe in search of higher yields, the euro will face broad-based weakening pressure.

2. Lower yields elsewhere: With the US Treasury-German bund yield spread at record highs, US fixed income should be a primary beneficiary of European demand. The prospect of a rise in the federal funds rate in mid-2015 could be less of a worry as European demand will keep US long-term rates anchored at lower levels.

3. Good emerging markets could survive: The global financial crisis has seen a rotation of current-account surpluses away from emerging markets to Europe. At face value, this makes emerging markets more vulnerable. But the sum of countries’ current-account surpluses is larger now than before 2008, so there is more spare capital around. European current-account recycling should mean that the marginal demand for emerging-market assets is likely to go up, not down.

4. Search for yield could resume. Global fund flows could return to high-yield bonds and real-estate investment trusts as well as some emerging-market bonds with strong fundamentals.

 

Komsorn Prakobphol is head of the strategy unit at Tisco Wealth. He can be reached via www.tiscowealth.com or [email protected].