A fragile labour market

By Peter De Coensel,
CIO Fixed Income at DPAM



    • The inflation theme has been dominant in market discussions. Notwithstanding that inflation and inflation fear is important in the debate around the direction of long-term rates, other factors merit more attention. We’ll briefly pause and reflect on the state of labour markets in the Eurozone. The shape of labour market rehabilitation will influence central banks’ reaction function across policy rate setting, bank funding conditions and duration and intensity of asset purchases. Current evidence points to a cumbersome path ahead for employment. Below scenario unfolds also in the US and the UK, but in a fashion that can be labelled as even more aggressive.

    • The impact of the pandemic on Euro area unemployment gives a false positive reading. Unemployment rose from 7.2% in February 2020 to 8.7% in July 2020. By Q4 2020 the unemployment rate had recovered towards 8.3%. Right after the Great Financial Crisis (GFC) of 2008-2009, Euro area unemployment rose towards 10%. By 2011 – 2012 the Eurozone fell victim to the Euro debt crisis lifting unemployment towards a high of 12%. The mending between 2013 and 2019 was spectacular pushing unemployment to 7.2% end of 2019. Over those 7 fat years the overall labour force grew by approximately 9 million. The corona crisis wiped out more then half of that advance over Q2 2020 as the labour force shrank by 5 million+. The rise of unemployment towards 8.7% by the end of Q2 2020 is muted thanks to the job retention schemes in the form of short time work or temporary lay-offs that governments rolled out. The labour force recovered solidly over Q3 2020, but remains well under end of 2019 levels. Over April 2020, job retention schemes (mostly people on short-time work) represented 15% of the German labour force, 35% for France, 30% for Italy and 21% for Spain. These numbers declined over Q3 but are expected to rise again towards above levels, as lockdown measures intensified over the past weeks. In the aftermath of the GFC, these numbers never exceeded 3.2%. Such job retention schemes help to keep unemployment stable in the short term, but require smart design in a way that limits undesirable effects. Yes, they reduce firms’ liquidity needs, allowing them to resume activity after lockdowns are lifted. Employment contracts are kept intact. But, job retention schemes entail deadweight losses (subsidising jobs that would not be lost) as well as displacement effects (subsidising unviable jobs). These might reduce long term efficiency of economies if used for too long as they block required economic restructuring.

    • Hiring and job postings indicators also remain depressed. These indicators bode ill for young professionals entering the job market for the first time. As digitalisation leapfrogged aggressively over the past year, we also question the future of temporary employees and people with a low level of education.

    • The ECB warns that we should be cautious when interpreting official labour market statistics. Job retention schemes helped contain an increase in unemployment or a stronger decrease in employment. They state: “However, it remains unclear how many of these workers will successfully move back to their normal working hours and how many may be at risk of losing their jobs…the sharp decline in labour market participation suggests that the slack in the labour market is substantially greater than captured by the unemployment rate. The crisis is likely to lead to an increase in labour reallocation needs, and these are expected to be greater the longer the pandemic lasts.” Effectively, higher structural unemployment might become our worst nightmare, as greater skill mismatches and dispersion of unemployment across geographies lead to an increase in the average duration of unemployment. So, as vaccination programs roll out successfully and the Eurozone reopens firmly over Q3 2021, we might see the unemployment rate running higher, as national government and EU (through the SURE program) labour market support wanes. Beware of a second unemployment wave across the Eurozone in late 2021 and over 2022.


    • A certain calm returned to the US Treasury markets last week. The yield curve bull flattened tentatively. With 2-year rates unchanged at 0.13%, 10-year rates dropped 3bp closing at 1.08% and 30-year rats closed at 1.83%, shedding 4bp. Demand for US TIPS was robust, especially at the 2-year point. July 2023 US linkers closed at -2.12%, a historic low. Market participants expect that the high in CPI will occur over 2021-2022. Longer term, the market is expecting US inflation to abate just above 2%. The 30-year auction past Thursday was highly successful as USD 24 billion came in at a yield of 1.825%, 1.4bp below its level in when-issued trading ahead of the bidding deadline. The core CPI December print coming in at + 1.6% as expected put a lid on rates. With the FED meeting scheduled on Wednesday the January 27, uncertainty over the Biden inauguration, presidential impeachment proceedings unfolding next to a heavy week in Q4 earnings releases and expectations, we do not find many arguments that will cause upward pressure on US rates over the next couple of weeks.

    • In EMU government, the week got nicely split in two halves. At the start of the week, 10-year German bunds made an attempt to reenter in the old -30bp to -50bp range, but participants received a cold shower thanks to an Italian political drama unfolding yet again. The moment most participants were focusing on the speed and length of vaccine roll-out programs, the party of Matteo Renzi called it a day and withdrew from Conte’s cabinet. This move robbed Conte of a working majority, exposing his administration to high uncertainty that might last days at best, weeks at worst. Moreover, on Thursday evening, the Conte cabinet agreed on EUR 32 billion increase in debt. This is about 30% more than the Finance Minister Gualtieri put forward the weekend before. German 10-year bunds received a renewed bid and closed the week at -54bp. The Bund-BTP 10-year spread increased by 10bp closing at 115bp. No one overboard, but it reminds us about less happy episodes in Italian government bond history. We expect little contagion towards other markets.

    • European Investment Grade (IG) and High Yield (HY) credit markets did not like the increase at the margin of uncertainty. Spreads were leaking and IG corporate bonds shed a small 7bp in performance versus -20bp for European High Yield markets. Primary markets are reopening with confidence. Central bank make sure that they play they role as liquidity provider of last resort with greatest distinction.

    • Emerging market (EM) debt recovered from a weak start thanks to a stabilisation in US rates and the US Dollar. Local debt performance was flat in USD terms while it returned +1% in EUR thanks to a lower EUR/USD.

    • The JP Morgan index for EM currencies (EMCI) was slightly negative vs the USD (-0.20%) and the index of EM sovereign credit returned -0.50% in USD due to a widening in spreads of the HY component of the index. In terms of flows, EMD funds continued to attract interest. Local currency funds saw inflows of USD 1.35 billion and hard currency funds inflows of USD 699 million, according to EPFR data.

    • In the meantime, supply kept its high pace with more than USD 11 billion of external debt placed by sovereign issuers. HY rated countries were a big contributor, with Benin issuing EUR 1 billion, the Dominican Republic (USD 2.5 billion) and Oman (USD 3.25 billion). The books attracted a lot of interest and investors were not afraid of buying some of the issues maturing in 20 and 30 years.

    • In response to the COVID outbreak Malaysia’s king declared a state of emergency, effectively suspending parliament until August 1, in a move that allows politically challenged Prime Minister Muhyiddin Yassin to avoid facing an election in the short term. While the impact of COVID is likely to negatively impact growth expectations, it reinforces the probability of a rate cut at the Bank Negara Malaysia meeting next week.

    • Ghanean local market was the hot spot of the week, as investors have rushed to buy GHGBs, attracted by one of the highest real yield in the world at around 18% for 3y maturity. The Ghana Cedi has held up well in 2020 (-3.10% vs USD), most of the political risk is now behind us, with the reelection of President Akufo-Addo. Also, most investors expect the government to issue a decent size on the Eurobonds market in the first quarter, which should replenish FX reserves of the country and giving more room to the Bank of Ghana in managing the currency.

    • Last but not least, Romania unexpectedly cut interest rates to a record low of 1.25% in an attempt to boost its economy, a move made possible by easing inflation for a 5th month in a row. Romania also faces the challenge of protecting its IG rating, with the new government pledging to bring the budget deficit from 9% last year to 3% by 2024.


Labour markets across the globe have been scarred deeply. Labour indicators are lagging economic indicators but warrant closer attention in this recovery episode. The pandemic might have exposed bigger and more structural labour market issues than consensus estimates.

Skill mismatches, waning of government support schemes and corporate cost control initiatives might all lead to unwanted choices and higher discontentment with the public at large.

The monetary and fiscal cooperation regime has to put “mending the labour market” as one of its top priorities. It will take time… a lot of time.


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