Pulse 2021: Old beliefs die hard in DE, FR & IT; Emerging markets debt relief – are we kicking the can down the road? US yields: Where the music plays

Some of the best things in a year tend to happen between July and September… Among them: our perspectives. This week, you can get ‘amped’ with our insights on how Europeans view political and economic hot topics such as climate change, Europe or their future prospects. Riptide with the latest on debt restructuring initiatives in EMs and how the creditor landscape is changing. And dawn patrol: Our take on the US yields against the background of the grand reopening and what our term structure analysis reveals.?

Allianz Pulse 2021: Old beliefs die hard

Allianz Pulse, our annual report to check the pulse in Germany, France and Italy; For its third edition, a representative sample of 1000 people in each country was surveyed about their views on political and economic issues, as well as their expectations for the future; key take-aways:

Building back stronger? Only 27% of all respondents believe that the Covid-19 crisis will strengthen solidarity in the EU (Germany: 23%, France: 27%, and Italy 30%)

Building back greener? Only 28% of all respondents agree with the goal of reducing emissions by 55% by 2030 (France: 23%, Germany: 26%, and Italy 35%)

Building back more digital? Only 30% of all respondents feel well prepared for the digital world (France: 27%, Germany: 30%, and Italy 34%)

The unforgotten crisis: As much as 50% of all respondents hold the view that their society is still suffering from the aftermath of the refugee crisis (Germany: 45%, Italy: 51%, and France: 53%)

The looming crisis: Only 13% of all respondents share the view that debt is not a problem at present, thanks to low interest rates (Italy: 12%, France: 13%, and Germany: 14%)

Please find our full report here.

Emerging Markets debt relief: Kicking the can down the road

The Covid-19 pandemic and related global economic crisis triggered an unprecedented shift in public debt sustainability in the developing world. Emerging Markets (EMs) and Low-income Developing Countries (LDCs) have been hit harder by the post-Covid debt surge, reflecting their heavy debt-service burden compared to Advanced Economies (AEs). A decade ago, the share of government interest payments in fiscal revenues was nearly the same (on average around 6%) for the three country categories. Since then, the debt-service cost has fallen for AEs (to 4% in 2020), gradually increased for EMs (7.3%) and more than doubled for LDCs (13.7%). Despite the global economic recovery that is already underway (+5.5% in 2021, the fastest recovery in the past 40 years), we expect increased debt distress in EMs and especially in LDCs in the next two years and further sovereign downgrades as well as some defaults. Low-income countries will need a minimum of USD450bn in order to step up their spending response to Covid-19, to rebuild or preserve foreign exchange reserves and to offset the long-lasting scars of the crisis. In the absence of a comprehensive solution, heavy debt burdens may generate a permanent global divergence between rich and poor countries. Current debt restructuring initiatives will certainly continue to kick the can down the road and are likely to fall short of their objectives. The IMF’s new USD650bn SDR allocation is a step in the right direction but will be no game-changer. The G20/Paris Club Debt Service Suspension Initiative (DSSI) has the merit of including China, for the first time, into a coordinated debt relief initiative. Yet, it will bring only “temporary” relief (i.e. payment deferral without debt cancellation) in 2021 and covers a very small portion of the debt-service burden (excludes EM borrowers and private creditors, for example). More insights into the changing creditor landscape of public debt and the IMF-coordinated “Common Framework” in our full analysis here

US yields: where the music plays

In the real economy, the “Grand Reopening”?party has just started. However, bond markets seem to price a large inflation discount (10y breakeven inflation at 2.4%) together with a subdued long-term economic outlook (10y real yield at -0.9%). These expectations seemingly diverge from the Fed’s recovery narrative. But what if expectations do not diverge at all and other factors are behind this situation? Term structure analysis reveals that the YTD increase of US 10y nominal yields is almost entirely due to a repricing of the uncertainty about the post-Covid-19 economic and monetary equilibrium (risk premium). Long-term expectations for inflation and the real equilibrium rate haven’t been adjusted, at least so far. We see limited upside for the expectations in the coming months. The upside for the risk premium seems also contained as a substantial risk buffer already built up. Our analysis also shows that a large share of the YTD increase in long-term US yields was due to a repricing of the QE tapering path. The path that is now priced in seems highly ambitious compared with the tapering dynamic after the Great Financial Crisis.?All this supports our view that US 10y yields will remain largely unchanged at year-end with a less than 15% probability to exceed 2% at the end of the year. Please find our full analysis here.