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Bond Outlook April 28 2010

From risk accepting to risk aversion in under a week! What lies behind the present emergency? Greece, of course, but what more, and where will it lead?

Bond Outlook [by bridport & cie, April 28th 2010]

A mere fortnight ago it seemed that markets were calming and the time had come to consider longer-term issues (“draining the swamp”). Now the alligators have returned in force and markets are again operating in emergency mode. Greece is, of course, in the limelight, but is really just the weakest point to reflect two major issues:


  • the general danger of widespread government indebtedness
  • a European Monetary Union with a responsible central bank but sovereign countries of widely varying fiscal disciplines


Let us begin by addressing the first of these issues, by quoting a well-known figure (with slight editing to avoid repetition):


failure to reduce the budget deficit and increasing levels of government debt relative to the size of the economy may push up interest rates over time, inhibiting capital formation and productivity growth, impairing growth and even putting the current recovery at risk. Budget deficits may eventually erode the confidence of bond investors in the management of US fiscal policy, driving yields higher on Treasury borrowing.


With the difference that we have would have made less use of “may”, these words reflect exactly what we have been writing for many months in this Weekly. In fact, they were uttered by Bernanke this week in front of the National Commission on Fiscal Responsibility and Reform, established by Obama. Very similar comments, without aiming especially at the USA, were made by the IMF in its Global Financial Stability Report.


They reflect the great fragility of the US-led recovery, so dependent on cheap money and unsustainable government deficit spending. In a sense the current situation is just like that before the recession: the USA and many other countries living beyond their means and hoping that they can continue in this mode indefinitely. The only difference is a shift from household profligacy to government profligacy.


Despite the usual reaction to emergencies with a flight to T-Bonds, we stand by our warning that long maturities in T-Bonds or almost any government debt offers less protection than high-class corporate bonds.


The Greek crisis may or may not be solved. In favour of it ending in default and/or Greece being kicked out of the EMU are the huge numbers involved – far greater than the current rescue package. In favour of a solution is the political pressure to keep the single currency project alive and well. This is also in the interests of the many banks in France, Germany (and Switzerland) with Greek exposure: 99% of Greek debt is held abroad. Perhaps the political considerations will win out over time, but, if they do, there must be a loss of sovereignty among euro deficit countries. That cannot be exactly music in the ears of would-be king maker in the UK, Nick Clegg.


Although the EMU and IMF are the main actors on Greece, the OECD has published a concrete set of recommendations to turn the Greek economy around. They include the obvious, like reducing the unaffordable pension cover, and the more subtle like encouraging private enterprise.


The Senate hearings on Goldman Sachs show how much both political parties and the public can no longer tolerate the banking industry as practised in Wall Street. Despite the Republicans holding back a debate on banking regulations, momentum is building. Even if Goldman “get away with it” in strict legal terms, the loss of moral authority and confidence is enormous, and cannot be restricted to a single investment bank. What a pity that the Senators are not better briefed on the issues at stake; they might then address the implicit conflict of interest between market-making and proprietary trading.




(?) USA: consumer confidence sharply improved in April (57.9 vs. 52.5 in March). New home sales have expanded 26% and prices increased by 0.6%. Long-term unemployment now represents 44% of total unemployment


(–) UK: unemployment increased by 8% in the three months to end of February, representing 2.5 million workers, the highest level since 1995


(+) Europe: the PMI manufacturing index for the euro zone reached 57.5 in April vs. 56.6 in March


(+) Russia: GDP increased in March to by 4.9% yoy


(+) Japan: exports increased 43.5% yoy


(–) Greece: Greek bond yields are continuing their stratospheric rise after the downgrades and market doubts about a viable solution


(+) Hungary: the central bank has lowered the target overnight rate to 5.25%, its lowest ever


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


Recommended average maturity for bonds (corporate/government)


07.04.2010 2013 2014 2013 2016 2015 2017 2017 2017

Dr. Roy Damary

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