Bond Outlook by bridport & cie, March 21 2013

This Weekly is one day later than usual because the traditional Wednesday slot was taken by a bridport-sponsored conference led by independent economist Andrew Hunt. It happens that the Cyprus crisis was gaining attention in the news just as Andrew was considering the world economy in its separate parts and as a whole. Cyprus epitomises the malfunctioning euro zone and what it means when the ECB promises to do “whatever it takes” to keep the euro zone together. That apparently includes confiscating people’s savings in Cypriot banks. Not only has the Cypriot parliament rejected such a plan, but criticism is growing everywhere that the last thing any economy needs, in particular the euro zone, is loss of confidence in its banks. Do the EU leaders really want us all to keep our money under the mattress?

Our guess is that the confiscation plan will be dropped. The role of the Russians is unclear, but their demanding a naval base in exchange for a contribution to the bail-out is a possibility.

If the euro zone holds together (and that requires federalisation), the peripheral countries will have to adjust to much lower standards of living than the Northern countries. Andrew draws a parallel with the UK and its booming home counties but poorer provinces. Yet the political struggle over the euro is not just “North vs. peripherals”, but is taking place within Germany itself. In particular the Bundesbank and the ECB are at loggerheads. If the former’s view prevails – which we think unlikely but not impossible – then the euro experiment will be over.

What has the Western world’s economy become dependent on, even though it is not doing what it was meant to do, viz. bring about a return economic growth? The answer, of course, is quantitative easing. Our view is that the addiction to QE is itself strong evidence that economic growth is far away. Our conference brought out how the money being printed is recycling through the financial system and not reaching the real economy. Even the much heralded housing recovery in the USA is not a source of spending power since households are rebuilding their balance sheet by net repayment of mortgages (which is no bad thing).

The continuation of QE more or less everywhere in the West means that central banks have become the buyers of last resort for all sorts of debt, and the guarantor of indefinite cheap money. There may be a parallel here with the “Greenscam Put” of yesteryear, which supported the stock market until the bubble it created finally burst. What the Fed did in the 1990s is now being practised by almost every Western central bank!

Other key points presented at the conference included the massive increases in China’s labour costs and the likelihood of competitive devaluations of Asian currencies. Andrew saw this as a deflationary threat to the West, but our view is a little more sanguine as we observe the manufacturing repatriation taking place in the USA and UK (epitomised by noodle manufacture returning to Leeds!).

Our clients are very active in USD denominated bonds at present. The trade is two-way, but for the first time in many months selling is approaching the level of buying. The sales are in areas of lower-credit, mainly financials and corporates.

The conference showed problems in every economic zone, with the possible exception of Switzerland, where positive GDP growth and negligible inflation must make it the envy of the world. But beware complacency and damage being wrought to the financial system by the capitulation of FINMA to foreign pressures.

Macro Focus

United States

Consumer prices climbed 0.7% in February and 2.0% over the past 12 months reflecting a jump in energy expenses. Producer prices rose respectively 0.7% and 1.7%.

Retail sales climbed 1.1%, and companies boosted inventories in January to gear up for the pickup in demand. Manufacturing in the New York region expanded for a second month in March and industry managers grew more optimistic about the future.

Housing starts rose by 0.8% last month to a 917,000 annualized pace, houses and permits for future construction climbed 4.6% to 946,000, the highest level in almost five years.

Eurozone

Industrial output fell 1.3 % in January year on year.

Construction output also fell in January by 1.4% from December and 7.3% from a year ago, the most in four months as declines in France and Spain offset a gain in Germany.

Consumer prices increased 1.8% from a year ago.

United Kingdom

Inflation accelerated in February to the fastest pace in nine months. Consumer prices rose 2.8% from a year earlier and producer prices increased 0.8% from the previous month. Higher energy bills and a weaker pound have fuelled price pressures in recent months.

Jobless claims fell less than forecast and a wider measure of unemployment rose for the first time in a year as the number of young people looking for work climbed. Wages grew at the slowest pace since 2009.

London home sellers raised asking prices this month by 1.9% from February to an average £ 496,298.

Switzerland

The Swiss National Bank, forecasting the economy to grow by as much as 1.5% this year, renewed its vow to defend a limit of CHF 1.20 to the EUR to lessen the risk of deflation and recession.

Investor confidence fell for the first time in six months in March on resurging uncertainty about Europe’s debt crisis.

Producer and import prices advanced for a sixth month in February, led by higher domestic costs (+0.1% from a year earlier). Import costs fell 0.7% from a year earlier, while producer prices rose 0.4%.