Bond Outlook by bridport & cie, March 13 2013

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The Italians are not alone in protesting against excessive austerity. Everywhere, traditional political parties are being disavowed and unconventional parties growing, some explicitly committed to euro or EU withdrawal.

The contradictions between the current economic situation, and the performance of financial markets, pose a major challenge to those of us who like rational explanations! Why, for example, have US economic indicators generally turned positive despite sequestration and political impasse between the two parties? Why is the euro zone subject to such criticism, yet peripheral yields have failed to return to the high levels of last year? Indeed, if the euro zone economy is so poor, why are new corporate bond issues proving so numerous and successful? And why is the demand from our own clients focused on high-quality debt in Europe, but on high yield in the USA?

 

A partial explanation for rising stock markets is undoubtedly “faute de mieux” (lack of alternatives). Indeed interest rates are so low that the only way they can move is up, even if that move is some way off. These conditions of course discourage bond investment, while giving reassurance to stock markets, and we are inclined to agree with Axel Merk’s assertion that “Stock evaluations may be driven more by printing money than by fundamentals”.

 

In Europe , the impact of Draghi’s promise (“whatever it takes”) has, rightly or wrongly, assured investors that the EUR is safe, even in the face of Italian domestic politics once again threatening to destabilise the currency bloc.

 

What is very clear on both sides of the Atlantic is that there is great dependency on cheap money driven by quantitative easing. So long as QE is in place, we have to remain very suspicious of assumptions that sustainable economic growth has returned. The current belief that the USA has the more solid recovery has led many to suppose that the leading contender to be first to wean itself from QE will be the USA. We are far from convinced.

 

The dependency of the American economy on foreigners continued buying of T-Bonds to cover the current account deficit has been there so long that it is rather taken for granted that it will go on indefinitely. Treasury bonds are not an attractive investment, and when the Chinese buy them, it must be through gritted teeth. Yet, it need not be the Chinese who lead a rout of T-Bonds. Any reduction in demand, be it domestic or foreign, could lead to a fall in the dollar, and a rise in the interest rates of new Treasury issues. This danger is the flipside of the stock market rally: the USA is dependent on T-Bond issue at low interest rates; increase those rates and the recovery will be strangled. That is why the Fed cannot drop QE.

 

The European rebellion against excessive austerity is gathering speed. Even Martin Wolf in the FT is now harshly critical of the stubbornness of the UK’s coalition government. The rebellion is extending to popular disavowal of all traditional political parties, of which the most blatant example is found in Italy. In the UK, too, there is disenchantment with the Coalition, and growing support for the UK Independence Party. In Germany a new political party is being formed under the name “Alternative für Deutschland” with a single objective: to abandon the euro. As for France, the rebellion against Hollande is led by senior business leaders leaving the country for Belgium or the UK.

 

For our readers, the best advice we can give today is to be cautious. The optimism of the financial markets seems excessive.

 

Our next Weekly will be delayed by one day, as on Wednesday 20th March, bridport is hosting a breakfast presentation in Geneva by independent economist, Andrew Hunt.

 


Macro Focus

 

 

United States

 

Factory orders fell by 2% in January, the most in five months, weighed down by lower demand for military hardware and commercial aircraft. Demand for durable goods decreased 4.9%, while non-durables climbed 0.6% on gains in petroleum and chemicals.

 

Payrolls increased more than forecast in February and the jobless rate fell to a five-year low of 7.7%. Employment rose by 236,000 with hiring in construction up by the most in almost six years.

 

Workers’ productivity fell 1.9% annualised in Q4, the most in four years, while labour expenses increased as companies added workers and boosted hours. Expenses per worker increased at a 4.6% rate.

 

Eurozone

 

The economy recorded a third straight decline in the fourth quarter. Shipments from the euro area dropped 0.9%, helping to drive gross domestic product down 0.6%. Imports also fell 0.9%. Investment declined as the sovereign debt crisis pushed the region deeper into recession

 

In Germany GDP fell 0.6% in Q4, compared with a 0.2% increase in the previous three months. France’s economy contracted 0.3%, while Italy’s dropped 0.9%. Spain’s economy shrank 0.8%.

 

United Kingdom

 

Industrial production fell 1.2% from December as factory output declined, with manufacturing down 1.5%.

 

Home prices fell 0.2% from the previous month to an average £162,932. However, from a year earlier, prices rose 1.1%. The outlook for the property market remains unclear. An index of house prices fell for a second month in February as interest from potential buyers failed to rebound.

 

Switzerland

 

In February Unemployment held at 3.1%, the highest level in two years, while consumer prices continued their longest decline in at least four decades at -0.3% from a year earlier. That is the 17th straight month of annual declines, the longest stretch since at least 197

 

 

Dr. Roy Damary