Bond Outlook March 4th

While hope of a “bend in the L” for summer looks forlorn, we still see chinks of light in darkness: China\s stimulus, corporate bond issues and the US anti-foreclosure programme.

Bond Outlook [by bridport & cie, March 4th 2009]

Maybe we relish the role of a voice crying in the wilderness. In the days of the Goldilocks economy we warned that the unsustainable had to end. Now, when almost every commentator and piece of news is black, we feel bound to look for chinks of light. Yet it has undeniably been a week of growing darkness:

 

  • Stock market lows
  • House prices declining still further
  • Talk of default in Eastern Europe and even amongst euro-zone countries
  • AIG announcing record quarterly losses (and Bernanke criticising them publicly)
  • European banks more leveraged, and therefore exposed, than US banks because the Basel Accords allow weighting of assets whereas US banks still have a simple equity to asset ratio (10%) – not that US banks provide a good example of prudence!
  • The automotive industry threatening plant closures
  • Such an increase in money supply in the USA that inflationary forces could completely overcome the deflation risk

 

Light piercing the gloom is indeed hard to find, but we some see in:

 

  • The ability of certain large corporations to raise funds through bond issues
  • A plan by the Obama Administration to reduce foreclosures, a step towards stabilising house prices, which is in turn fundamental to stopping the decline in economic activity
  • China announcing a new stimulus package for domestic demand (USD 585 billion)

 

It is not much, but it allows us to cling to the hope that the downward leg of the L-shaped recession will be over by the end of this year, although not so early as the end of the summer as we had thought.

 

In the bond market, the issue of new corporates is losing steam. Companies in industries such as utilities and tobacco have little problem getting bonds away, neither do non-discretionary consumer good firms like pharmaceuticals and food. There is demand outside these fields but it is cooling, a measure of which may be seen in GE’s CDS having exceeded 1,000 bps. While our recommendation for the last two months has been in favour of new corporate issues, our sense now is that the secondary market has some very attractively priced corporates.

 

The situation in government bonds is very complex. With CDS rates near 200 bps for some euro zone countries, there are EUR government bonds offering bonds of 4% and more. Whether an investor finds this attractive depends entirely on his appreciation of the risk of default. Our view is that default by a country like Greece is so unthinkable that the ECB, the European Commission and the “virtuous” European governments will simply not let it happen. Investors taking our view may well therefore see value in these euro zone bonds, with particular emphasis in the case of Greece on inflation-linked issues.

 

In emerging markets USD-denominated bonds are seeing declining spreads and EUR-denominated wider. This replicates the USD still enjoying safe-haven status, while begging the question how long this can last. “As long as the situation of European banks remains unclear” is a possible answer.

 

Focus

 

(+) New issues: EUR 300 billion worth of new bonds issued already this year in the world, of which half was in the USA, followed by the UK. France and Germany

 

(–) East Europe: total foreign borrowings amount to USD 1.7 trillion. Repayments due this year are equivalent to one third of GDP of the region

 

(–) USA: GDP down 6.2% per year in Q4; AIG lose USD 62 billion; stock markets lowest since 1997; the Government has become the largest shareholder of Citigroup; further decline in sales of existing homes

 

(–) Switzerland: GDP down in Q4 by 0.6% compared with a year earlier

 

(–) Spain: In February unemployment reached 3,48 million, the highest in 13 years

 

(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question

 

Recommended average maturity for bonds.

 

No change.

Currency: USD GBP EUR CHF
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Dr. Roy Damary