Christine Lagarde, 70, said on Thursday, Oct. 29 that she'll leave the European Central Bank in February. Her term was set to run to next October. Hours later her bank held its deposit rate, what it pays banks to park cash, at 2.5%. The quiet decision hid a loud problem. France's 10-year bonds now yield 5%, the most since 2002.
The European Central Bank, the eurozone's version of the Fed, is squeezed from two sides. Prices in the eurozone rose 3.8% in the year to September, against a 2% goal. European natural gas is up 36% this month, and Europe heads into winter with low reserves. That argues for higher rates, and investors expect a hike in December. But France's bond market just went through a big selloff. Investors think the ECB will be wary of going much higher, for fear of adding pressure on France's fragile economy. The ECB said the energy shock is "likely to drive up inflation and lower growth." The euro and bond yields fell after the decision, the Journal's Chelsey Dulaney reported.
Britain got the same message a day earlier
On Wednesday, Oct. 28, Britain's new government unveiled its first budget. It trims the deficit to 4.2% of output, from 4.4%. A year ago the promise was 3.4%. The budget watchdog now sees growth of just 1% next year, down from 1.6%, and real wages that likely stagnate. There was a 100-pound heating payout, about $133, for poorer households, help for young homebuyers, and a higher tax on bank profits. Investors are demanding more to lend to the U.K. and France, the Journal's Max Colchester and Chelsey Dulaney reported. British bank shares still rose, because the tax rises were smaller than expected.
Lagarde's successor inherits all of it. Among the front-runners is Spain's Pablo Hernández de Cos. The Dutch economist Klaas Knot is also in the running. Whoever gets the job faces cheap Chinese imports squeezing German carmakers, a strained relationship with the U.S., and a French bond market under stress. French President Emmanuel Macron will help make the pick before he leaves office in May.
Our read
This is Fixed Income, IN02. Bond buyers in Britain, France and the U.S. are sending the same message. All three governments carry heavy debt, and none wants to cut spending or raise taxes much. So lenders charge more. France's 10-year is at 5%. Britain's closed Thursday at 5.301%. Ours closed at 4.988% on Thursday, after 5.044% on Fed day. The Fed and the ECB are both leaning toward hikes, not cuts. That's why we keep safe money in Treasury bills and floating-rate paper (SGOV in 49 books, USFR in 14) and avoid long bonds. TLT sits in 4 older books, and nothing was added. A long bond abroad carries the same risk as one here. Our Europe fund (VGK) is held at weight in 11 books; nothing added.
For your own plan, the thing this story touches is the bond fund in your 401(k), especially any international or "global aggregate" fund. Pull up its fact sheet this week and find the line called duration. A duration of 7 means a one-point rise in yields cuts the fund's price by about 7%, whether the bonds are French, British or American. If that number is bigger than you'd guess, bring it to your next review. You check the roof before the storm, not during it.