Bond Outlook by bridport & cie, October 10 2012

By:
Published on:

Indecision by politicians is now knocking on to corporations, who are obliged to withhold investment until the economic uncertainties are resolved.

This is not a time for making wholesale changes to investment portfolios. The growing economic uncertainties around the world make us caution investors against seeking what used to be ‘normal’ yields by buying the bonds of unfamiliar companies. Likewise, what used to be one of our favourite routes to higher yields, emerging market bonds in local currencies, no longer provide a sufficient spread to compensate for the exchange-rate risk. If yield is the target, longer-term government debt in Europe is, for the time being, more appropriate.

 

Why this note of caution? Because, as we suggested last week with the question as to whether our politicians could merit the term “leaders”, there is drift and indecision in the world’s three largest economies: the USA, the euro zone and China.

 

The USA is fast approaching the oft-quoted “fiscal cliff” early in 2013, when tax increases and spending cuts at the federal level will amount to 5% of GDP. Budget rebalancing is of course essential, but the pace needs to be moderate. This year, indebtedness of both government and banks has been increasing. It is as if everyone is partying on debt until the Presidential election is over, without considering the bill which will be presented next year. As we have maintained for many months, no responsible actions will be taken by US politicians until the election is over, and six weeks of “lame duck” Congress are also unlikely to be decisive.

 

Uncertainly at the political level translates into indecision by companies. Most have sufficient cash reserves, but are hesitant to invest. Even the decrease in US unemployment carries with it a sting. About half the new jobs created are with the government, and the other half in food, drink and the health sector. That may be symbolic of the current “eat, drink and be merry, for tomorrow we fall sick.”

 

In Europe, “politicians seem to have interpreted the ECB’s actions as a licence to twiddle their thumbs” (The Economist). We cannot cease repeating that the respite given by Draghi must be used by politicians to move forward on federalisation. With Spain slow to ask for a rescue package, and German reluctance over bank recapitalisation and supervision, it is hard to be optimistic.

 

Even China has stalled in its reforms of the inefficient state-run enterprises as the Communist Party changes leadership.

 

The small ray of optimism we offered last week on the UK is still shining, but hesitantly. It is interesting to note that private sector employment in the UK is improving, while the USA is still expanding government employment.

 

Has the time come to reconsider deleveraging via austerity? History suggests that this approach has never worked well. The alternative is to accept inflation, plus low interest rates, as a route to reducing debt. Yes, it is a bad thing, but it may be the lessor of two evils, and it has worked before.

 


Macro Focus

 

 

United States

 

The unemployment rate fell to 7.8% in September, as employers took on more part-time workers. The economy added 114,000 workers last month after a revised 142,000 gain in August. Consumer confidence climbed for a sixth straight week. Mortgage applications climbed to the highest level in more than three years. However, orders placed with U.S. factories fell in August by 5.2%, the most in more than three years.

 

Confidence among U.S. small businesses cooled in September as fewer companies said they planned to hire or invest in new equipment, a survey found. The National Federation of Independent Business’s optimism index fell to 92.8 from an August reading of 92.9. However, service industries in the U.S. expanded in September. The Institute for Supply Management’s non-manufacturing index climbed to a six-month high of 55.1, from 53.7 in August.

 

Euro Zone

 

Euro-area retail sales increased for a fourth month in August by 0.1% from July as demand rebounded in Germany. German factory orders fell as the sovereign debt crisis dampened the outlook for growth. Orders, adjusted for seasonal swings and inflation, fell 1.3% from July, when they had risen 0.3%.

 

The Portuguese debt agency exchanged bonds with a total of € 3.76 billion maturing next year at 3.1% yield to maturity for securities due in 2015 at 5.12%, reducing its 2013 repayment burden as it tries to regain access to long- term debt markets.

 

United Kingdom

 

The economy grew at its fastest pace in five years in Q3, at 0.8 %, after one-off disruptions in the prior three months, compared with 0.1% in the quarter through August. However, manufacturing fell by 1.1% in August after a rise of 3.1% in July, and the trade gap widened. The Bank of England is completing the £ 50 billion round of QE started in July, obliging a decision on whether more stimulus is needed.

 

More U.K. banks are prepared to lend money for real estate developments than they were a year ago. 66% of lenders say they are likely to provide development project finance in the coming five years, up from just over half of respondents a year earlier.

 

Switzerland

 

Q2 Industrial Production rose 4.6% YoY; overall the Swiss economy is expected to expand 0.9% this year, and1.3% in 2013 (KOF). Consumer prices declined 0.4% from a year ago after falling 0.5% in August

 

Swiss unemployment held steady in September at 2.9%, suggesting companies are holding onto their employees even as the economy cools.

 

Global

 

The International Monetary Fund cut its global growth forecasts to 3.3 % this year, and 3.6 % next year.

 



Dr. Roy Damary