The U.S. repo market is stabilizing, European growth faces internal and external headwinds, and fiscal risks are rising in Japan---1124 Macro Distillation

The U.S. repo market is stabilizing, European growth faces internal and external headwinds, and fiscal risks are rising in Japan---1124 Macro Distillation
  1. Recently, the pressure in the US repo market has eased. The market expects the Federal Reserve to accelerate its Treasury purchase program, and officials’ statements suggest that the purchases may start ahead of schedule. Although the total amount of outstanding Treasuries remains high, the marginal improvement in collateral financing demand has kept repo rates relatively stable.
  2. Next year, the European economy will display a pattern where cyclical improvement coexists with structural pressures. Germany’s fiscal expansion may turn the overall fiscal stance of the eurozone to neutral. Intensified export competition from China will drag down European trade, while weak labor supply and slow reform progress continue to provide resistance. The European Central Bank is expected to maintain current interest rates.
  3. Japanese Prime Minister Sanae Takaichi is continually expanding fiscal stimulus packages, accelerating the rise in government bond yields and fueling ongoing market concerns. Although there is limited risk of a ratings downgrade at present, long-term debt dynamics still pose a risk of deterioration.

I. US Repo Market Stabilizes

US Repo Market Stabilizes (Citibank)

Citibank notes that recently the pressure in the US repo market has eased. The market expects the Federal Reserve to accelerate its Treasury purchase plan, and officials’ statements suggest purchases may be initiated ahead of schedule. Although the total amount of outstanding Treasuries remains high, the marginal improvement in collateral financing demand has kept repo rates relatively stable.

  1. Repo rates are stabilizing.
    • Since late September, the minimum/maximum two-week volatility range for SOFR/IORB (Secured Overnight Financing Rate / Interest on Reserve Balances Rate) has narrowed to the lowest level.
    • TGCR (Tri-party General Collateral Rate) trading volume has increased significantly recently, with an increase of over $130 billion since the end of October.
  2. Treasury purchases may start ahead of schedule.
    • According to the October FOMC meeting minutes, participants generally agreed that "in the long term, it is desirable to increase the share of Treasuries in the SOMA (System Open Market Account) portfolio."
    • Fed Treasury purchases will support financing markets, as the surge in Treasury inventory and collaterals has been the main source of pressure in the repo market.
    • After the FOMC meeting, Fed officials suggested that actions to purchase Treasuries to maintain ample reserves might start sooner. SOMA manager Roberto Perli said, "Based on current conditions, we may not need to wait too long."
    • The purchase program is expected to be announced at the January FOMC meeting, with estimated monthly purchases of $20 billion in Treasuries.
  3. Treasury supply is slowing, supporting repo rates.
    • The scale of Treasury settlements is contracting, and this trend will likely continue through December.
    • The Treasury Department explicitly stated in its November refinancing statement that it would reduce the size of Treasury issuances in December and has already cut the size of the six-week Treasury auction by $10 billion.

Although outstanding Treasuries will remain at a high level, the marginal decrease in collateral financing demand should help support repo rates through year-end.

Repo rates are not expected to decline further, but their pace of increase should slow compared to the high levels in October.

II. European Growth Faces Internal and External Resistance

European Growth Faces Internal and External Resistance (Goldman Sachs)

Goldman Sachs notes that next year, Europe’s economy will show both cyclical improvement and structural pressure. Germany’s fiscal expansion may turn the overall eurozone fiscal stance to neutral. Intensified Chinese export competition will drag on European trade, while weak labor supply and slow reform efforts remain obstacles. The ECB is expected to keep interest rates unchanged.

  1. Cyclical growth will improve significantly next year.
    • Germany’s fiscal expansion remains on track; major budget or extra-budgetary military fund spending did not accelerate in October, but infrastructure and climate fund spending saw strong growth. This fiscal plan could boost German economic growth by about 0.5 percentage points annually in 2026 and 2027.
    • While the rest of Europe maintains a contractionary fiscal stance, Germany's shift implies that eurozone-wide fiscal stimulus in 2026 will be neutral, a significant improvement compared to previous years.
  2. The labor market is resilient, inflation is subdued, supporting consumption.
    • Employment growth continues to slow, but unemployment remains near historical lows and wage growth is gradually normalizing.
    • Oil and natural gas prices are expected to fall next year, keeping overall inflation low, which will support real household income and consumer spending.
  3. Despite easing global tariff tensions, external and structural pressures on European growth are increasing.
    • After the recent US-China truce and US tariff reductions on food, trade policy uncertainty has declined. Demand from most European export destinations is healthy, and the drag from tariffs is expected to fade gradually by 2026.
    • Intense export competition from China may drag on European trade, with Germany most affected, followed by Italy, while France and Spain are less impacted.
  4. The ECB is expected to keep rates unchanged as medium-term inflation expectations remain at target.
    • If external pressures spill over to European demand and pricing, rates could be cut again next year.

The recent downward revision in GDP growth paths, weak labor supply outlook, and lack of decisive reform under the Merz government all add to Europe's pressures.

III. Japan’s Fiscal Risks Are Heating Up

Japan’s Fiscal Risks Are Heating Up (Barclays)

Barclays points out that Japanese Prime Minister Sanae Takaichi is continuously expanding the scope of fiscal stimulus packages, driving government bond yields higher and fueling ongoing market worries. While immediate downgrade risks are limited, long-term debt dynamics remain at risk of deterioration.

  1. Japanese Prime Minister Sanae Takaichi’s ever-expanding fiscal stimulus package is speeding up the rise in Japanese government bond yields.
    • Due to reduced bond issuance, the yen rate market was briefly calm at the end of October.
    • In early November, Sanae Takaichi announced the abandonment of the longstanding basic fiscal surplus target, and the scale of her economic policy package continues to grow. This has led to a rapid rise in Japanese government bond yields, with term premiums on 10-year and 30-year JGBs both surpassing the highs seen in April due to "Liberation Day" tariff news.
  2. The market is uneasy about the upcoming fiscal package.
    • If Sanae Takaichi opts for an early election to strengthen her mandate for expansionary economic policy, market concerns regarding the outlook for further fiscal expansion will intensify.
  3. Even with some degree of fiscal expansion, Japan’s government debt/GDP ratio will still show a declining trend over the next decade.
    • This is because rising interest rates take almost ten years (the average maturity of JGBs) to be fully reflected in government interest expenses (i.e., inflation tax).
    • Although current downgrade risks are limited, as interest payments gradually converge to inflation levels, Japan’s debt dynamics could deteriorate within ten years, and improvement in the debt/GDP ratio alone will not be enough to dispel market concerns.

The total scale of the current economic package has reached 21.3 trillion yen, including 17.7 trillion in fiscal spending and 2.7 trillion in tax cuts (1.5 trillion in gasoline tax reductions and 1.2 trillion in income tax deduction cuts). This will surpass last year’s 13.9 trillion yen and become the largest stimulus package since COVID-19.

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