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May 29 2015

Silk and Spice

The recent rise in nominal Bund yields is related mainly to the inflation upturn anticipated by the German FIG, along with the uptick in commodity price inflation. The current configuration of ECRI’s leading indexes reveal cyclical pressures on yields, but in any event, they are a long way from getting back to earlier highs because the recent cyclical re-rating of inflation expectations has occurred against the backdrop of a sea change in structural expectations, given slowing trend growth and lingering lowflation.
While the ECB’s latest efforts at QE are certainly responsible in part for driving real yields so low, they have been trending down for years. Thus, the growing recognition of the decline in trend GDP growth, not only in Germany, but also in virtually all other major economies, has surely played a role in depressing yields. This includes the advanced economies, but also China, a key destination for German exports.
Chinese authorities have clearly recognized that their old export- and investment-driven growth models are no longer sustainable, and have been trying to reorient the economy towards consumer spending. A critical element of China’s long-term response harkens back to its historical trade ties, including those with many of its Asian neighbors, through plans to build infrastructure to boost to trade with those partners. As a recent article in Foreign Affairs puts it, China has released “a blueprint for what it calls the Silk Road Economic Belt and the 21st-Century Maritime Silk Road – often shortened to ‘One Belt, One Road’ [to] make China a principal economic and diplomatic force in Eurasian integration.”

Meanwhile, India has launched the “Mausam” project, aimed at reestablishing India’s historical maritime routes with its ancient trade partners in and along the Indian Ocean, and Africa is about to create a Cairo-to-Cape Town free trade area bigger than the European Union.

In essence, with trend growth tailing off in the “global North,” the major economies of the “global South” have decided to shift their long-term focus to “South-South trade,” because that is where the growth will be in the 21st century. This is a commanding long-term vision with the potential to reshape the drivers of Chinese growth, in particular – and Asian growth, in general – in this century and beyond. But, over the next few years, it will not have a material impact on Chinese growth, which will stay in a secular downtrend, alongside the secular decline in trend growth in the advanced economies that makes them likely to dip more easily and often into recession. Thus – especially for the developed economies in “the yo-yo years” that will continue to prevail – the increasingly shallow waters of economic growth will expose more recessionary shoals, demanding even closer attention to cyclical tools to help navigate these shallows.

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