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Bond Outlook by bridport & cie, November 30 2011

“Federalisation or bust!” should be the slogan of the euro politicians and bankers now meeting.The ghost of Alexander Hamilton must be wryly smiling. Is Sarko a latter-day Hamilton?

Will December the 9th 2011 be for Europe what July the 26th 1790 was for the newly independent United States of America? The latter date was when the Continental Congress accepted (on a second attempt) the proposal of Alexander Hamilton, the Secretary of the United States Treasury, that the Federal Government take over the debts of the thirteen former colonies. This move established the credibility of the United States as a sovereign nation and cemented the colonies as States within the Confederation.


Hamilton’s ghost must be smiling as he sees the European politicians arguing just as vociferously against his proposal as his colleagues did in Congress over two centuries ago. “Let’s just repudiate the debts!” “Kick the spendthrifts out of our Union!” “Stick it to the private sector!” “Central control means German control!” “Printing money leads to inflation – remember Weimar’s hyper-inflation!”


Who is fulfilling the role of Hamilton as chief advocate for federalisation? Probably Sarkozy, supported by a weak cast of EU and ECB officials. Yet Merkel is also playing a role, not to hold back the federalisation process, but rather to make the terms and conditions more severe. By playing hard to get, she is protecting her domestic political flank, and encouraging fellow euro zone members to concede even more sovereignty.


We have at least been consistent in our view of the euro zone crisis over the past few months. Federalisation is the only way to end the crisis: a Euro Ministry of Finance with the teeth to control the budgets of individual members, and to issue bonds in its own name, plus, of course, its own “independent” central bank.


Much as we loath the idea of quantitative easing, there are circumstances – and they are present on both sides of the Atlantic – when there is no alternative if the financial system is not to collapse.


For a few days while European politicians try to act like leaders, financial markets should be relatively calm. Whether this is just the eye of the storm or an exit to a more permanent stability depends so much on the political meetings within the EU and with the IMF. We remain moderately optimistic, although “optimism” has to be understood as many years of very little economic growth. Indeed, our 2008 coining of the expression “an L-shaped recession” has proven more prescient than we would have wished.


At this time of the year, it is always more difficult to close trades as market makers reduce their books. There is however an additional phenomenon this year, reflecting the hesitation of investors to follow a clear fixed-income strategy. Investors wish to keep their maturities short, e.g. 2 or 3 years. In contrast, corporations would rather issue at 5 years or more. This mismatch has led to many new issues being delayed, presumably till the euro situation has clarified.


For the first time in the 13 years of the current “Weekly”, economic news about the USA seems to have fallen off the radar screen. Such is the dominance of the problems in Europe. The Americans seem more interested in the gender-related activities of the Republican contenders!


Macro Focus

Euro zone: a EUR 6bn auction of German last Wednesday 10-year bunds managed to find buyers for only EUR 3.64bn, causing yields on sovereign bonds all over Europe to rise yet further. Angela Merkel ECB continued to reiterate opposition to Eurobonds – this time in the face of a European Commission plan. The IFO Institute’s survey of German business confidence rose to 106.6 this month, up from 106.4 in October. Fitch cut Portugal’s credit rating from BBB- to BB+


ECB: the OECD called for the bank to increase support for troubled European sovereigns, possibly by channelling funds through the IMF


Hungary’s debt was cut below investment grade by Moody’s as the country announced a plan to seek IMF ‘insurance’ on its sovereign debt


USA: the Conference Board’s consumer confidence index increased from a revised 40.9 in October to 56 in November – the largest MoM rise for eight years. Consumer spending and orders for durable goods increased by 4.7% and 6.9% YoY in October, from 5.2% and 5.3% in October. Housing sales increased by 1.3% YoY in October and household debt declined 0.6% QoQ in 3Q


UK: growth for this year and next was substantially revised down by the OECD and Office of Budgetary Responsibility; both now see real GDP increases of less than 1% for both periods. In response, the Chancellor George Osborne announced a 40bn GBP ‘credit-easing’ programme of government guarantees for borrowing by small and medium-sized companies, a deregulation of firing and planning laws and a cancellation of fuel duty increase, while reiterating emphasis on deficit reduction


BoE: notes from the Bank’s November Monetary Policy Committee revealed that several members believe increased monetary stimulus may be necessary in 2012


Switzerland: the UBS consumption indicator rose from 0.82 in September to 0.91, still close to August’s two-year low of 0.80. The OECD has cut its prediction for Swiss economic growth in 2011 from 2.7% to 1.8%

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