Submitted by Taps Coogan on the 10th of April 2019 to The Sounding Line.

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Allianz chief economic advisor Mohamed El-Erian recently spoke with CNBC about what is keeping US bond yields low and the biggest risk to the global economy: Europe.

Mohamed El-Erian:

“This theme of divergence is the right one. It’s not about a synchronized slowdown. It’s about divergence. But for the marketplace, remember how sensitive corporate revenues and profits are to the rest of the world…”

“(This earnings season) I think we are going to hear a lot about a couple of things. One is weakness abroad, particularly in Europe. Europe is slowing much more than people expected. Secondly, we are going to hear about risk aversion. How there is an extra element of risk aversion as consumers pull back in the rest of the world…”

“It’s all about Europe. People are trying to explain this (low bond yields) in terms of the US and because of that, I think they worry a little too much about the yield curve and inversions. This is all about Europe… The one relationship I always look at is the 10-Year Treasury versus the 10-Year Bund. It’s at 250 basis points (2.5%). Historically, that’s really elevated. So if you want to know where our yields are going to be beyond five years, look at Europe. And if you think they are going to go up, it’s because you think Europe is going to recover. if you think they are going to go down, it’s because you think Europe is going to do even worse. It’s all about Europe and people should realize that when you make a US interest rate call you really are making a European economic call… Would you bet on a team where your five main players, your difference makers, are all having problems? …Brexit in the UK. In France, there are protests going on. In Spain, there is an election that’s likely to be inconclusive. In Italy there is political issues and in Germany you have a major political transition… The EU is fragmenting in terms of decision making. So, I really worry about Europe and I’ll stress again, the market should pay greater attention to the weakness in Europe.”

With regards to the prospect for a sustained uptick in European growth, the problems are several fold. Monetary policy in the Eurozone is already extremely accommodative and has been that way for a decade, to little avail. As Mario Draghi noted in his last press conference, even with the ECB holding its balance sheet steady, it will increase its market share of European sovereign bonds. In others words, the ECB’s balance sheet is so large that it will eventually run out of qualified sovereign bonds to buy, even holding its balance sheet constant. It can move on to buying other assets, but as we have seen in Japan, the stimulative effects are very limited.

With regards to demographics, the EU’s working age population has been declining since 2010 and will continue to do so for the foreseeable future, and that’s assuming that the UK doesn’t leave. If the UK were to leave, the EU would lose the largest country it has whose population is still growing. The UK is the largest single counterbalance to the EU’s declining and aging population.

With regards to economic policy, there is not, and has never been, sufficient popular or political support across enough of the EU for the sort of structural economic reform that would be needed to enhance its competitiveness and productivity.

The trajectory of European growth is lower and it’s hard to see any factor reversing that trend.

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