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Banking

Bond Outlook March 10 2010

This week we raise ten questions yet without clear answers. Together they are disturbing. Readers might think of their own answers, but “status quo” is unlikely to be amongst them.

Bond Outlook [by bridport & cie, March 10th 2010]

The new bond issue by the Greek Government was reportedly 4-5 times oversubscribed. Yet our company was both pleased, and surprised, to receive a full allocation on our subscriptions for our clients. This suggests that the “spin” over Greece is continuing.

This raises only one of the many unanswered questions that we are (and investors should be) pondering during this relative lull in financial markets, and in light of the current mood of cautious optimism about economic developments. Produced below is a list of those other questions, to which we add our reservations on Greece to reach a round number (with apologies to Moses!):

1. What will be the aftermath of quantitative easing?

2. Can every country export its way out of trouble?

3. Are the huge internal deficits of “Western” countries sustainable?

4. If they are not, how can they be reduced?

5. Is inflating them away a serious option?

6. How will increased government borrowing affect the cost of private sector borrowing?

7. How can governments wrestle back economic control from leading banks?

8. How can household spending increase during deleveraging and low house prices?

9. How can a single currency area cope with one central bank but several Treasuries?

10. To what extent are the Greek and general Euro problems being managed by “spin”?

We have struggled with most of these questions for many months, and will not repeat our tentative answers here. Raising all ten questions together, however, rather suggests that the current calm is a prelude to more dramatic events to come. As issues mainly facing developed economies, they also fit into a world view that the shift of economic power from “West” to “East” is well underway. Indeed, the latest data show that emerging economies, together, are now close to matching developed economies in GDP terms.

Investors should be cautioned, however, against arbitrarily chasing emerging market opportunities, at least where equities are concerned. Studies have shown that equity returns in fast growing economies are often lower than in stable ones. Fixed-income markets have been subject to less academic study, but we continue to believe that there is potential both in currency, and in credit, within many emerging markets. For some years we have recommended a component of selected EM debt in local currencies. There are of course limits on what is available and/or attractive, and our task is to make concrete recommendations, e.g. Brazil, Russia, South Africa, and Turkey. How regrettable that neither India nor China have an open international bond market.

In our more familiar world of corporate bonds, we observe the continuation of high numbers of new issues. Part of the reason is the ongoing reluctance of banks to lend, part is the moderate optimism about the economy. Two current trends are noteworthy: maturities are lengthening, and floaters are rare. By definition, supply and demand always match at a price, but issuers have the greater control over the mix. The message is clear: issuers are seeking protection against higher interest rates and yield curve steepening. We still urge caution before lengthening.

Focus

(?) USA: the ISM services index was 53 in February. House sales fell 7.6% in January. 36 000 jobs lost in February, unemployment is 9.7%

(–) GB: producer prices (PPI) increased 4.1% in February

(?) Europe: retail sales fell 0.3% in January over December, both in the Euro zone and the EU as a whole, where GDP increased 0.1% in Q4 over Q3

(–) France: unemployment reached 9.6% in mainland France in Q4 and 10% including overseas Departments, the highest in ten years

(–) Turkey: annual inflation was 10.13% in February

(+) Australia: economic growth of 0.9% in Q4 or 2.7% over 2009

(+) Russia: inflation declined to 0.9% in February and is running at 2.5 % for the first two months of the year

(+) Iceland: 3.3% economic growth in Q4 09, best performance since the problems of 2008

(+) Brazil: inflation 4.83%

(+) Switzerland: unemployment dropped to 4.4% in February from 4.5% the previous month. Inflation was 0.9% yoy versus 1% in January

(+) Rep. Czech: industrial production improved 3% in January over December. Consumer prices are stable

(!) China: fearing inflation, the Government is talking tightening measures

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

Recommended average maturity for bonds.

Stay short across the board.

Currency:

USD

GBP

EUR

CHF

As of 17.06.09

2012

2012

2012

2012

As of 21.01.09

Max. 2013

Max. 2013

Max. 2013

Max. 2013

Dr. Roy Damary

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