Bond Outlook by bridport & cie, September 14 2011

When will European politicians move from words to action? Saving the euro needs centralised fiscal supervision, a transfer mechanism, and a process for the joint and several issuance of sovereign bonds. Trichet calls this a Euro Zone “Ministry of Finance”. We often use the alternative term “federalisation”. The problem is German reluctance to take on a leadership role reflecting both their deep pockets, and their strong economy. Fear of their electorate explains why the German political leaders are so afraid to move beyond mere words. Where is the courage to spell out that the end of the euro, and a return to the Deutschmark, would mean such an increase in the exchange rate that German exports would lose much of their competitiveness, with a resultant surge in unemployment ?

We still (just) retain the confidence that the words of the German political leaders will eventually lead to real action. We quote as an example the Bundesbank’s Jens Weidmann; “either we make a big jump forward to a centralised Euro Zone structure, or backwards to each country being responsible for it own finances.” The latter means no more euro.

While politicians dither, markets are acting. The sub-prime crisis in the USA, where the underlying problem of spending beyond one’s means led to a banking crisis, ultimately dragged down the economy. In the Euro Zone, the incompatibility of 17 Ministries of Finance and one central bank has shown up initially as a Sovereign Debt crisis, and may, for institutions holding questionable paper, lead to a similar banking crisis, and ultimately, a similar economic outcome. It is these implications that should ultimately push the politicians into action, however it is still uncertain as to whether they are capable of taking action before Greece defaults.

Only rarely do we dare comment on stock markets. We were however struck by a recent FT analysis, which compared US and Japanese stock markets in the years following the bursting of their respective bubbles. If the USA, and presumably other Western markets, follow Japan’s example, stock markets will underperform, with increased volatility, for many years to come. We were struck because this ties in so closely to our view of likely GDP growth, and our description of the recession and its aftermath as “L-shaped”. It is hard to imagine a strong stock market performance in an environment of negligible (or even negative) GDP growth, although cheap money can produce such an unlikely scenario on a temporary basis. It is however difficult to foresee what tools remain open to respective governments to cheapen the supply of money from the present position!

One of our colleagues recently attended a Hong Kong conference on the Renmimbi, and the rapidly growing market for offshore bonds (“CNH”). This is all part of the unfolding move to the RMB becoming the world’s third trading and reserve currency. As HSBC state on their website, “The Chinese Renmimbi (RMB) is poised to become the world's reserve currency in the 21st century”. If rumours of Chinese participation in the Euro bailout are true, this might occur sooner than we all imagine.

Next week, we will take a break from our regular Weekly to provide a more detailed summary of our present thoughts on this increasingly important topic. We shall return to our usual politico-economic commentary on 28th September.

Market Focus

• Global: the OECD significantly lowered its forecast for global growth, predicting that quarterly growth in the second half of this year will average less than 0.2% a quarter, an annualised rate below 1%

• USA: import prices fell in August for the second time in three months. A survey forecasts GDP will expand 1.70% this year, down from the May forecast of 2.80%. The trade deficit narrowed, reaching a 3-month low. Mortgage rates tumbled to the lowest in at least four decades with the average rate on 30-year fixed rate loans falling to 4.12%. However, banks increased their lending to corporations in August by the most in almost three years. The poverty rate rose to the highest level in almost 20 years and average household income fell 2.30%

• Europe: CDS’s on European sovereign and bank debt rose to fresh record levels. Larger French banks were particularly hard hit as they denied rumours about struggling to access dollar funding. Moody’s downgraded both Societé Générale and Crédit Agricole and will assess “the implications of the persistent fragility in the bank financing markets, given the banks continued reliance on wholesale funding”. BNP Paribas remains on review for downgrade

• Germany: exports, adjusted for work days and seasonal changes, fell unexpectedly by 1.80%. Industrial production jumped 4% from June to July

• Greece: the cabinet voted to cut one month’s wages from all elected officials and impose an annual charge on all property for two years, to be levied through electricity bills, to ensure rapid collection. The move did nothing to slow the rapid rise in the cost of insuring Greek government debt, 5 year CDS now being over 5’600 bps

• UK: inflation accelerated in August to 4.5%. Manufacturing grew only 0.1% June to July. The government confirmed that it will force banks to insulate their consumer and investment banking units by 2019

• Switzerland: unemployment held steady at 3.00%. The KOF Swiss Economic Institute forecast Swiss GDP growth will slow to 1.9% percent this year and 1.3% in 2012

Disclaimer
This document is based on sources believed to be reliable, accurate and complete. Any information in this document is purely indicative. This document is not a contractual document and/or any form of recommendation. Expressions of opinion herein are subject to change without notice. We strongly advise prospective investors to consider the suitability of the financial instruments, based on the risks inherent to the product and based on their own judgment. It is not intended for publication. This document may not be passed on or disclosed to any other third party without the prior consent of bridport & cie s.a. © bridport & cie s.a.

September 14, 2011

Dr. Roy Damary