Bond Outlook by bridport & cie, July 4 2012
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Bond Outlook by bridport & cie, July 4 2012

So the vision of a fiscal union is being slowly backed into via a nascent banking union, thereby lightening the mood in financial markets. How durably?

Bond Outlook [by bridport & cie, July 4th 2012]

Since the EU summit last week, a number of positive signs have appeared:


  • liquidity has returned to bond markets (whether that will last is unclear)
  • the EUR has regained some poise
  • Ireland is returning to the international bond markets
  • Bulgaria has been able to place a sovereign bond in EUR at a modest interest rate
  • bond investors are cautiously returning to emerging markets
  • they (or at least our clients) are beginning to sell government bonds and move to corporates


Can it be that the problems of the euro zone have been solved? Of course not, but the steps taken in Brussels have given markets some assurance that the first tentative steps towards federalisation of the euro zone are being taken. These steps are focused on the formation of a banking union, with the ECB responsible for enhanced regulation, and the use of bail-out funds for direct loans to banks rather than to governments. This “separation” of the euro sovereign debt crisis from the banking crisis is very important. In reality they are intimately intertwined; the essential point is that insolvent banks can now be cleared out of the system, whilst government debt does not have to be increased through loans having to be made to banks.


A month ago we suggested that investors should not only hedge against failure to maintain the euro, but also against a more successful outcome. If the moves towards a fiscal union are made step by step over the many years required, there will be times of flight to quality and others, like now, when fear has abated and the attraction of German or Swiss Government bonds offering negative real yields (and sometimes negative nominal yields) declines. This warning is worthy of repetition; we would even use the emotive term “bond bubble” concerning these government bonds.


The ECB’s lower interest rates are positive news for companies and indebted households, but bad news for retirees and savers. As cheap money is thrown at the economy on both sides of the Atlantic, it bears remembering that it is merely a lifeboat operation, and does not address the underlying problem holding back most of the Western economy (and Japan), viz., over-indebtedness from spending beyond one’s means for many years. Belt-tightening à la Merkel is therefore necessary. The whole debate is about how far and how fast.


We console ourselves that at least the topic of balancing budgets is on the table in Europe, which is more than can be said for the USA. The euro crisis has taken eyes away from America’s problems, but the latter are very severe. Households have followed a diet of deleveraging, but government, at all levels, has hardly started. Only a break one way or another in the Democrat versus Republican stand-off can open the door to progress.


The Libor scandal has implications beyond senior bankers’ heads rolling; it has heightened the contempt for the banking industry among the public and politicians. Further regulation is inevitable, and risks being overkill, as Sarbanes-Oxley was in the USA after corporate scandals there.


Macro Focus

United States


The IMF has warned the United States of the danger of not solving the "fiscal cliff" scheduled for the end of the year.


United Kingdom


The Bank of England will almost certainly increase its quantitative easing




Madrid announced it is negotiating with the European Commission over the conditions using the euro loan for its banks. The Agency for Irish debt is returning to bond markets after nearly a two-year absence. It will offer € 500 million of Treasury bills at three months. IMF asks Germany to accept some inflation of wages and prices




Brazil has become the second largest issuer of corporate bonds in the U.S., primarily companies whose bonds are investment grade




RBA leaves interest rates unchanged at 3.50%. Building permits were up 27.3% against 5.0% expected




After ten years of absence from the bond market, Bulgaria has easily placed € 950 million at rates of 4.25% for 5 years


Dr. Roy Damary

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