Bond Outlook by bridport & cie, April 18 2012
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Bond Outlook by bridport & cie, April 18 2012

The debt crisis cannot be solved by pretending it is not there. Yet the leaders in at least two major countries have their heads in the sand.

This week we return to an old theme, over-indebtedness, and what to do about. We recognise that we run the risk of boring readers, but this is the dominant problem facing the developed world, and about which our political leaders are doing so little to resolve. They failed to listen to voices like ours before the crisis formally broke out, and they are still behaving like metaphorical ostriches now. A redeeming feature is that many European countries have at least put the issue on the table, and some are actually taking action with austerity programmes, albeit often in the form of “austerity light”.


How is austerity measured? The most obvious answer is the extent to which government spending is reduced, although paradoxically, even given these supposed reductions, overall government debt is still growing. The worrying feature is that the private sector has cut back, but it is the private sector that will be relied upon to drive economic expansion. There is however another measure of austerity, or rather of the results of austerity, and its real objectives: an increased savings rate, which enables household consumption not to exceed income and, most importantly, provides the capital for productive investment. How many governments go beyond asking themselves what they can cut when the question they should be posing is “How do we encourage saving and investment?”


One country that clearly is not asking the latter question is France. The theme of how to encourage saving and to reduce debt is not even on the political debating table. As The Economist asks, “Do the French really think that they can act like an island with no economic interaction with the rest of the world?” France is currently a greater menace to the European economy that Spain. At least the Spanish government acknowledges the problem of overspending and is addressing it, along with a little help from the ECB. France just does not want to know! (Although perhaps reality will begin to bite when the forthcoming election has passed)


Our belief about the euro experiment is that it can still succeed, provided the much-talked-of but little-acted-on fiscal union progresses. We have held that view for many months, but now we have to add a second proviso: “that France does not wreck it!”


Historically, we and many others have said that what cannot continue indefinitely will eventually stop, and we apply this dictum to governments and households spending beyond their means. It would appear that the USA is making a bold attempt to prove the dictum wrong! Yet there will eventually come a "bang point" (expression attributed to economists Reinhart and Rogoff), which is when lenders lose faith that they will be repaid and stop lending. Then it is not even “austerity light”, but a severe breakdown of the economy.


There are therefore two key countries in a state of denial: France and the USA. Both are paralysed in terms of rational decision taking until at least the Presidential elections are over. We can but hope that rational thought makes a renewed appearance after the elections.


Macro Focus

World: the IMF raised its global growth forecast from 3.3%, to 3.5% with the USA boosting the outlook even though recent improvements remain “very fragile”


USA: industrial production was unchanged in March for a second month. Retail sales rose more than forecast but the University of Michigan’s index of consumer sentiment cooled to 75.7 in April from a one-year high. The CPI climbed 0.3% MoM driven by higher wholesale prices and an increase in prices of imports like fuel and industrial materials. The trade deficit nevertheless narrowed as imports fell by the most in three years. An unexpected increase in claims for jobless benefits suggested a weakening labour market


Fed: the Fed resumed buying Treasuries as part of its programme to replace $400 billion of short-term debt in its portfolio with longer-term Treasuries in an effort to reduce borrowing costs further and counter rising risks of a recession


EU: industrial production unexpectedly rose by 0.5% in February, reflecting a weather-related surge in energy output. However, the trade surplus narrowed. The CPI increased at a faster rate than estimated, driven by soaring energy prices (2.7% YoY)


Spain: the 10-year yield climbed by as much as 18 basis points to 6.00 %. Bonds are trading close to levels that prompted Greece, Ireland and Portugal to seek EFSF support. Bonds plunged amid concern demand for the nation’s debt is waning after borrowing costs rose and it sold just above the minimum amount it planned at an auction, although the next round went better


ECB: to lower Spain’s borrowing costs as the regions debt crisis threatens to boil over again, the Central Bank will restart its government bond purchases rather than offer banks another round of unlimited three-year loans


UK: retail sales rose for the first time in three months in March as warm weather boosted demand for clothing and outdoor gear. The trade deficit widened to the most in three months as exports of cars and heavy machinery fell. House prices rose for a fourth month in March before the expiry of a tax holiday on some home purchases. Inflation unexpectedly accelerated for the first time in six months


CH: producer and import prices fell in March as the franc’s strength lowered the cost of goods from abroad by 2 % from a year earlier

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