-A firm and sustainable Eurozone agreement will be hard to come by, says Standish's Tom Higgins
-As Italian bond yields rise, fears of insolvency are coming to the fore
-Ongoing financial market volatility seems likely, but attractive investment opportunites can be found
Tom Higgins, global macroeconomic strategist at Standish, reacts to the latest news regarding the Eurozone sovereign debt crisis.
"The headlines over the past few weeks have been dominated by Greece, and its unresolved problems are likely to cast a shadow over markets for some time to come," says Higgins. "While the basics of the latest proposed Greek bailout seem to be heading in the right direction, as always, the devil is in the detail. For example, as yet there has been no explanation of how the increased leveraging of the European Financial Stability Facility (EFSF) would work. We believe that a firm and sustainable agreement from the Eurozone nations will be hard to come by, given the history of the single currency area, but they will do what is necessary," he adds.
Political will
"As has been the case on numerous occasions over the past 18 months or so, a ‘muddling through' is likely to be the short-term answer. In terms of the political picture in both Greece and Italy, the real concern for markets is the implementation risks associated with budget reforms." He continues, "That is why there is so much focus on the political change in both countries, with new governments expected to be in place in the coming months - Greek Prime Minister Georgios Papandreou tendered his resignation earlier this week, while on Tuesday the Italian Prime Minister Silvio Berlusconi promised to step down as soon as budget reforms have been passed. In both countries, the Troika (European Commission, European Central Bank and International Monetary Fund) seem very unlikely to distribute funds until a firm commitment from the respective governments is reached. At least the Spanish government, for example, has an opposition which is supportive of reform, and this should significantly ease the associated implementation risks," Higgins adds.
On Wednesday morning, the yield on the 10-year Italian government bond breached the 7% level that the experiences of Greece, Ireland and Portugal suggest Italy might have to seek emergency funds from the Eurozone. However, as things stand there are not enough funds in the EFSF to cover an Italian bailout, with just €250 billion of the original €440 billion left. "Clearly, we are currently seeing some concerted upward pressure on Italian government bond spreads and, should this persist, there is a real danger of Italy's problem shifting from one of liquidity to one of solvency," he says. "That would require urgent action. However, it has a bit of breathing space at the moment, with no rollover of debt until early next year."
Stronger union
"Meanwhile, we believe that the change of leadership at the European Central Bank (ECB) could have positive ramifications for the region," explains Higgins. "The new president of the ECB, Mario Draghi, took over from Jean-Claude Trichet last week, and we have already seen a cut in interest rates along with a ramping up of the ECB's purchase of Italian sovereign debt. Draghi already seems to be more flexible in his approach to the crisis than his predecessor, which should be cause for optimism," he says.
"Despite the ongoing state of crisis in the Eurozone, we believe that when all is resolved, it will be a stronger union as a result. There are also going to be plenty of disagreements, but the key factor is that it is in no one's interest for the Eurozone to fall apart," Higgins says. "There has been much speculation over a possible Greek exit from the euro but we think it is unlikely in the near term. Such an event would have long-lasting negative effects on Greece, with a likely banking collapse as well as a sharp devaluation of its new currency. Meanwhile, the tough fiscal austerity plans that it currently faces would seem positively comfortable compared with what it would then be faced with," he warns.
Volatility is here to stay
"As mentioned, we expect yet another period of ‘muddling through' and this is unlikely to change unless there is another new major shock," says Higgins. "Elsewhere, we are seeing slight improvements in other areas of the global economy, which might prompt a slight decoupling of markets. The US economy now looks likely to avoid a return to recession, while better-than-expected economic news in China also gives us cause for tempered optimism," he adds.
"In terms of our positioning at Standish, we are maintaining neutral positions in peripheral Eurozone countries such as Spain, Italy and Belgium, given the policy risk associated with possible ECB interference, but have no exposure to Greece, Portugal and Ireland. We also expect further weakness in the single currency now that the ECB has shown a willingness to cut interest rates. While we don't see much value in US Treasuries, we believe that high quality US credit looks attractive as US recessionary fears fade, while a focus on quality should be beneficial given the continued volatility concerns," he says. "Meanwhile, we still like emerging market local currency debt given that a number of emerging economies boast solid fundamentals - average debt-to-GDP of around 30% compared with 100% in the developed world. However," Higgins concludes, "no one seems likely to be immune from the ongoing volatility in financial markets."
Headquartered in Boston, USA, Standish is a specialist active fixed income manager investing in global fixed income markets and across the full credit spectrum.
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