Bond Outlook by bridport & cie, June 27 2012
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Bond Outlook by bridport & cie, June 27 2012

The EC has come up with a vision for future Europe. Now it will be seen if first the politicians then the voters sing up to it.

Bond Outlook [by bridport & cie, June 27th 2012]

The negotiating stances of the European politicians will give plenty of opportunities for analysis by future historians. In this context, we are struck by the vision for the future of the monetary union unveiled by the European Commission ahead of the summit under the title “Towards a Genuine Economic and Monetary Union”. It corresponds closely to the federal structure we see as the only means to save the euro:


  • a European Treasury, with a degree of control and sanction of individual country’s budgets and levels of indebtedness
  • common Eurozone borrowing power (Eurobonds by another term)
  • a banking union (a single bank regulator and deposit guarantee system)
  • joint policies to encourage growth
  • democratic legitimacy via national parliaments


A major problem is that this is a vision for ten years’ time, whilst the problems it sets out to solve are immediate. Another issue is that what Brussels wants may not be what each country’s voters actually desire. Nevertheless, establishing a long-term vision is better than no vision at all. If all the leaders can sign up, it will provide a framework for the step by step approach which will now be followed. As we are experiencing with the present crisis, there will be a series of fire fights, but unlike at present, we hope that each is extinguished by positive steps forward. Thus we remain cautiously optimistic that the euro can be saved.


That is not to deny that Merkel’s opposition to common bonds, and any lessening of austerity measures, is a huge stumbling block. Within Germany, the people may well be on Merkel’s side, but the opposition politicians (and, we suspect, her allies) are not. The SDP leader, Sigmar Gabriel, has stated that German voters have not understood that Germany is the great beneficiary of the EU, and would suffer from a massive recession if the euro were to fail. This theme will dominate the coming years’ election campaigning. With that surname, he has a large amount of annunciation to do!


It is almost certain that the UK will refuse any further loss of sovereignty, despite this being an essential part of the vision. That will lead to a “two-speed” Europe of the euro zone, and the ‘rest’. So long as the vision focuses on the euro zone however, it is realisable.


Within the euro zone members themselves, Germany is seen as the main roadblock to federalisation. . We concur, but would also point out that the French, especially French Socialists, have always jealously guarded budgetary independence. The issue for Germany is almost the opposite: Germany feels pushed into the driver’s seat in a nascent federal system, but would prefer a back seat. Only future historians will be able to explain whether this reflects past disasters, or an unwillingness to provide the finance needed.


The underfunding of future pension liabilities is a common press theme that we have often mentioned in our Weeklies. The situation is even more precarious when it is realised that, in the USA at least, forecasts of future revenues are based on the assumption of an 8% average annual return, whilst long term bond yields, a key driver of annuity rates, are near all-time lows. There may be among our clients those who can achieve such a rate of return in today’s climate, but they must be few and far between. Low interest rates advantage borrowers and disadvantage savers. The latter include retirees, who represent an ever larger proportion of the population, and whose spending power can only go down to the detriment of the economy.


Pension funds must rue the day when inflation was the problem, but real interest rates were nicely positive.


Another old theme of ours is the lessening of the role of the USD as the world’s dominant reserve currency. It seems that Russia is taking on the AUD for 1% of its reserves – a small but interesting development.


Macro Focus

United States

Leading economic indicators rose 0.3% in May after a 0.1% drop in April, propelled by a jump in home-building permits, which more than offset manufacturing declines. Mortgage rates for 30-year fixed loans at record low level (3.66%) encouraged demand for new homes.


The FOMC extended its Operation Twist programme and will swap $267 billion in short-term securities with longer-term debt through to the end of 2012. The FED will add to its record stimulus should the economy fail to make sufficient progress in creating jobs. In addition, Bernanke has repeatedly warned lawmakers that a fiscal cliff threatens the economy.


Congressional leaders are weighing whether to delay automatic federal spending cuts until March 2013. The $1.2 trillion in automatic spending cuts over a decade, half of which would affect the Defence Department, are scheduled to begin in January 2013


Euro Zone

An index of consumer sentiment in the 17-nation euro area fell to minus 19.6 from minus 19.3 in May. This trend is also present in the northern countries. German Ifo business confidence index fell to the lowest in more than two years in June. Consumer confidence in the Netherlands dropped to the lowest level in nine years.


The European Central Bank said it decided this week to relax some rules on the collateral that banks can offer in exchange for central bank funds. The Governing Council will lower rating thresholds and amend eligibility requirements for some asset-backed securities


United Kingdom

Manufacturing demand and retail sales rose: an index of factory orders increased to minus 11 from minus 17 in May (which was the lowest since December), and sales including auto fuel gained 1.4% from April.


Bank of England Governor Mervyn King was overruled for the first time since 2009 as he joined a push to expand stimulus amid rising jobless claims and growing risks from Europe’s debt crisis. The Monetary Policy Committee voted 5-4 to keep its bond- purchase target at £ 325 billion this month



Swiss investor confidence fell to the lowest level in five months in June. An index of investor confidence and analyst expectations that aims to predict economic developments six months in advance fell to minus 43.4 in June


Dr. Roy Damary

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