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The lingering effects of the U.S. Treasury Yields & Stimulus on Europe

Authors: Ashna Gupta & Bryce Yeo Region Head: Sauradeep Bhattacharyya Editor: Harsh Didwania


Abstract


This article strives to analyse the difference in the economic recovery trend in Europe vis a vis the United States, from the adverse effects of Covid-19 and pinpoint the possible explanation for the inconsistencies in their trajectories.


Introduction


Some of the biggest problems faced by the continent of Europe include the slow rollout of Europe’s pandemic recovery fund, sluggish vaccination inoculation, tightening of Covid-19 lockdown throughout the region, spread of highly contagious coronavirus variants, and social-political instability (riots). On the other hand, the U.S. economy is expected to experience a much better recovery from the adverse economical impacts of Covid-19. Its major drivers include a more advanced immunization push and President Joe Biden’s $1.9 trillion stimulus in effect.


United States


Recently, the ten-year U.S. Treasury yield rose to its highest level since February 2020 at over 1.63%.(Wall Street Journal, 2021). Moreover, there have been rising expectations of the U.S. economy bouncing back with the covid-19 vaccine rollout and fiscal stimulus package. An improvement in the risk appetite of investors can be seen in their purchase of stocks rather than bonds. The market also witnessed a spike in people’s inflation expectation which drove bond prices lower and yields higher. This weaker demand for debt was evident in February’s “disappointing auction of seven-year U.S. Treasury notes” that played a role in pushing up yields as well (Duguid, 2021).


As a result of higher treasury yields, the demand for the U.S. dollar has gone up among income-seeking investors. This is because when government bond yields go up, investors from around the world are encouraged to purchase the U.S. bonds, driving prices down. Therefore, the demand for USD increases and the currency strengthens.


Europe


In contrast, Europe’s economic recovery has been very pale. German equivalents to the U.S. Treasury Yield which is the benchmark for the region, rose as high as -0.293%. (Wall Street Journal, 2021). Consequently, the Euro depreciated against the U.S. dollar.



Economic Impact on Europe

The EU has a current account surplus with a positive net export value - contributing for 15% of the world’s trade in goods.



Furthermore, Germany contributed 30% of the EU’s exports to non-member countries and accounted for more than one fifth (22 %) of the EU’s imports, holding the highest share of extra EU trade in 2020. There is no doubt that Germany is one of the most important players in the EU's net exports.


A weak currency may further help the E.U. gain market share in exports as its goods become less costly compared to goods priced in other stronger currencies. This will in turn lead to robust economic growth and job creation while increasing profits for businesses conducting in the Europe region.



However, Net Exports merely compromise 3.61% of the EU's economy. This means that the depreciation of the Euro may not potentially affect Net Exports much.


Political Impact on Europe


With the implementation of stricter measures against Covid-19, many Europeans took to the streets and protested against such policies. Nations such as Germany, the Netherlands, Austria, Bulgaria, Romania, Serbia, Poland, and France saw demonstrations of varying magnitude depending on local conditions.


In addition to the challenges faced by rising pressure on the healthcare system, the European politicians have many other hurdles to cross. This trade-off of ‘health versus the economy’ has been a widely debated topic in recent times (Alvarez et al. 2020, Eichenbaum et al. 2020, Farboodi et al. 2020). Many E.U. nations have witnessed a change in the ruling political party during the Covid-19 crisis.



Growing number of cases and new emerging variants of Covid-19 have placed even more pressure on the politicians of Europe. The trust in political institutions may shift based on perceptions of government responsiveness and performance during the pandemic. Covid-19 threatens the existing trends of political fragmentation with a rising dissatisfaction with the status quo, thereby increasing the risk of political instability.


Future Outlook


Europe is one of the hardest hit regions of the Covid-19 pandemic. New waves of Covid-19 infection and lockdowns raise fear amongst investors, thereby leading to a drop in investments as well as the GDP of the European Union. Lockdowns caused the economic output to shrink by almost 9% last year. Furthermore, if politicians within the European region are unable to pivot from the pandemic, we may witness higher political instability. This in turn will lead to a lower inflation expectation and higher savings among people, causing a bigger recession or even an economic depression.



References


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12. The political consequences of the Covid pandemic | VOX, CEPR Policy Portal. (2020). Voxeu.org. https://voxeu.org/article/political-consequences-covid-pandemic

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