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Prospects for Europe Bond Markets by Sidstone, Gray & Partners

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Prospects for Europe Bond Markets by Sidstone, Gray & Partners - Prospects for
bond markets in mainland Europe are uncertain. Not all markets elsewhere will be
affected, and some may even continue to benefit from the problems in Europe. Th
e latest evidence on the economic performance is encouraging. Retail sales rebou
nded sharply in March; non-farm payrolls increased at the fastest monthly pace f
or three years in the same month; and both manufacturing and service sector outp
ut was higher.
The Fed is continuing to maintain a safe attitude. The statement after the lates
t meeting of its Open Market Committee is more encouraging, short-term interest
rates have been left unchanged once again, and the unwinding of the stimulatory
measures that were introduced to counter the recession is only proceeding at a v
ery modest pace. Both the economic background and the policy of the Fed is conti
nuing to support the market. However it is clear that the bond markets in mainla
nd Europe face far more serious problems. The economic recovery is only proceedi
ng at a slow pace, and short-term interest rates are likely to remain low; but t
he massive fiscal deficits and their possible consequences are offsetting any po
ssible benefits. Much now depends on developments in Greece. Despite a humiliati
ng appeal to the IMF and to other member countries for help in financing its mat
uring debts, its bonds have been downgraded to â junkâ status because of doubts about th
rescue operation, and fears about the poor economic performance.
Prospects for Europe Bond Markets by Sidstone, Gray & Partners - If the Greek a
uthorities can implement the austerity measures that are being demanded before a
ny loans are granted, then the threat of default on Greek bonds may be reduced,
and there will be more time for other countries that are in similar difficulties
, Portugal, Spain, Ireland, and even Italy, to take corrective action. But the s
ituation clearly remains extremely uncertain, and this has persuaded investors t
o take evasive action, and to push yield spreads between stronger and weaker bon
ds to record levels. It was only after considerable hesitation that the Greek go
vernment made the formal request for aid. It was clearly concerned that the soci
al unrest that has already occurred in the country would make it extremely diffi
cult to implement even more extreme austerity measures; but in the end it had no
choice. The request has produced a provisional agreement for the IMF to provide
â ¬15 billion in loans, and for the other member countries of the euro-zone to provid
e â ¬30 billion, with the amounts varying according to the respective size of the lend
ing country.
The gilt edged market has remained relatively stable over the past month, despit
e the uncertain situation in the UK. There has been evidence of a further modest
improvement in the economic background, and the Bank of England is holding shor
t-term interest rates at low levels. But the UK also has very serious fiscal pro
blems, and there are doubts whether the new government formed after the forthcom
ing general election will be able to cope adequately with those problems. It is
possible therefore that it has been the disaster in the bond markets in mainland
Europe that has been the main reason why the gilt edged market has performed so
well. The economy is clearly continuing to benefit from the monetary and fiscal
policies that were introduced to counter the recession; and so although unemplo
yment remains high and the housing market recovery is very fragile, the recovery
in activity is continuing.
The Office of National Statistics has recently estimated that growth in the firs
t quarter of the year was only at a 0.2% rate; but it is likely that this estima
te will be revised higher, and we expect that growth will be around the 2% level
this year. However this is not likely to persuade the Bank of England to make a
ny early moves to push short-term interest rates higher, and so the gilt edged m
arket will continue to receive considerable support. The Japanese bond market ha
s remained unchanged over the past month. The recovery from recession in and so
there is political pressure for new policies to counter deflation, to monetise t
he government debt, and to push the exchange rate sharply lower to encourage the
export effort. However the Japanese authorities have also been warned that they
must prepare an aggressive plan to repair the fiscal position, or risk a downgr
ade in the countryâ s credit rating. Fitch Ratings has recently said, that â in the absen
e of sustained economic recovery and fiscal consolidation, government debt will
continue to rise, placing downward pressure on sovereign credit and ratings over
the medium termâ . This is the second time in less than six months that Fitch has ex
pressed concern about the fiscal position; and Standard and Poorâ s has also cut its
outlook on Japanâ s AA long-term rating to negative this year. So far these comments
have been ignored, and Japanese institutional investors have continued to invest
massive sums in the bond market. It is unlikely that this situation will change
quickly, and so the Japanese government does not face the possibility of a sove
reign debt default; but if no action is taken, and economic growth remains disap
pointing, it seems inevitable that the pressures must eventually push yields hig
her.