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In a recent Special Report our Global Fixed Income Strategy service has updated its sovereign risk analysis. According to the results, fiscal constraints due to heavy debt loads in the US, Japan, and the UK are depressing their sovereign risk scores. Meanwhile, peripheral Europe is on the mend. Although the sovereign ranking methodology is not intended to predict spreads, the relationship between CDS spreads and our sovereign risk score highlights that the risk fundamentals in Spain, Italy, France and the UK are similar. However, investors are not well-compensated for the risks in the latter two countries.
The investment strategy of our fixed income team currently reflects an underweight recommendation for French sovereign debt. This week’s news that the French budget shortfall is larger than expected points to further deterioration in credit quality for that county, and the lack of monetary flexibility works against France’s credit score.
In contrast, we remain overweight gilts because UK policymakers are determined to cut its debt load even at the expense of short-term growth (although if they completely choke growth, our long-term solvency measure will deteriorate further). Loose monetary policy will keep gilt yields low and a fiscal risk premium is unlikely to be priced in.
This post was originally published by the BCA Research blog.