Bond Outlook by bridport & cie, September 19 2012
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Bond Outlook by bridport & cie, September 19 2012

Rejoice that hope has returned to the euro zone, but keep your eyes on whether and how reforms are pursued, and be worried that printing money has become universal.

Are there any major central banks who are now not printing money? The Fed has followed the ECB in moving to QE3, Switzerland has been printing CHF to defend its Franc ceiling, and the BoJ has expanded its purchases of JGBs. The UK has never really stopped its on-going programme of Gilt purchases.


Yet there is still no significant inflation. Whether one chooses to blame the demographics of ageing populations, long-term deleveraging after the excesses of the previous decade, or a combination of both, the greater fear is that of weak economies causing deflation, and off-setting the inflationary pressures of cheap money. Our parallel over four years ago, when the Fed began its first programme of providing cheap money, was with a person suffering from severe influenza being given aspirin and told to get back to work. Low interest rates keep economies turning, and are even the right action in present circumstances. They are however but a short-term fix, not a long-term cure. The latter requires matching standards of living to the added value of each economy.


Europe begs for reforms (employment laws, pension age, health care, etc.), and the USA begs for budget balancing. Draghi’s economic and political acumen are to be greatly admired. He has bought time for the political leaders to pursue reforms in their respective countries, and to move to a federal structure for the euro zone. They must make good use of that time, lest financial markets again lose confidence.


One of the immediate impacts of the Draghi programme is that the primary market for corporate bonds has become hyper-active. Part of the explanation lies in the need to clear a backlog after many months of doubts about the survival of the euro. A greater proportion than usual of buyers of new issues are taking quick profits on the secondary market, but the fact remains that the European corporate bond market is rapidly returning to “normal”, and that can only be good news. We would expect the new issue frenzy to calm down within a couple of weeks.


In the current active fixed-interest market, asset-backed securities are finding an expanding role. These include, but are not limited to, residential-mortgage backed bonds, especially in Europe. In the USA, they are more likely to be commercial-mortgage backed securities, but that probably reflects residual fear of securitised debt from the sub-prime crisis.


Just as housing in the USA was the immediate cause of the economic crisis (while the underlying cause was, and remains, spending beyond one’s means), so the housing market has to be restored to health for the US economy to return to growth and lower unemployment. QE3 focuses on agency rather than Treasury bonds, and appears therefore to be specifically aimed at housing.


Demonstrations against foreign countries, and attacks on foreign-owned businesses, just do not happen in China without government encouragement. Causing Japanese-owned factories to close, and putting off any company seeking to invest in China, is a very strange way to pursue claims to islands (and to the associated natural resources). There must be more to this than meets the eye: an attempt to divert criticism from the inadequacies of government performance to an outside “enemy”? A deliberate policy to turn away direct foreign investment? It will be intriguing to learn the real motivation of the Chinese Government.


Macro Focus

United States


Industrial production shrank -1.2% YoY in August and capacity utilisation decreased to 78.2%. The Empire Manufacturing index dropped from -5.85 to -10.41. Nevertheless, three consumer confidence indicators were up and retail sales increased 0.9 % in August.


All price indicators reflected a surge in energy costs. Producer prices climbed 2.0% YoY in August and the consumer price index rose 1.7%.


Euro Zone


Industrial production increased in July (+0.6% MoM). However the YoY figure remains largely negative, at minus 2.3%.


Inflation accelerated, also due to rising energy costs, with consumer prices increasing 2.6% from a year earlier.


The ZEW index of investor and analyst expectations climbed to minus 18.2 from minus 25.5 in August.


Retail sales in the Netherlands, the fifth-largest economy in the euro area, fell 4% in July from last year.


United Kingdom


In August, jobless claims fell the most in more than two years as the economy continued to create jobs despite the recession. Unemployment-benefit claims fell 15,000 to 1.57 million, but the unemployment rate increased to 8.1%.


Inflation slowed. The CPI in August was 2.5% YoY, versus 2.6% in July. Although U.K. inflation is cooling, it is outpacing wage growth, undermining consumer spending.




Production and import prices slipped 0.1% from a year earlier after declining 1.8% in July.


Dr. Roy Damary
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