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EDR: 2012: change or continuity on bond markets?

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Governments will once again be in the firing line in 2012. Debt, budgetary retrenchment and growth are the three big themes that will dictate market trends. ….


Etienne Gorgeon, Head of fixed income and credit, Edmond de Rothschild Investment Managers



          For professional investors and advisers only


          For the most optimistic observers, the Chinese Year of the Water Dragon will see a rebound. Pessimists, however, point to persistent uncertainties. Etienne Gorgeon, Director, fixed income and credit, sets out his analysis of the current environment and presents his investment strategies.    

          THE CHALLENGE OF GOVERNMENT REFINANCING IN THE EUROZONE: POTENTIAL OVERCROWDING
          EUR 800bn: this is the colossal amount Eurozone governments need to raise through bond auctions in 2012. Italy, which is expected to sell EUR 220bn  in debt, is the focus of attention as its 10-year yields are still hovering around 6%. But the loss of France’s triple A rating had been largely anticipated and so failed to wreak the havoc some had been forecasting. For the time being, the impact on French yields is still modest but the downgrade led to the EFSF (European Financial Stability Facility) rating falling to AA. The result, as we had expected, is that Europe is no longer an AAA, but rather an AA, zone.  
          Heavy government funding requirements are also  a cause for concern because of the danger of
          overcrowding. Sovereign borrowers will hog market liquidity at the expense of other economic agents and are prepared to use coercive means. They might, for example, introduce special measures to encourage banks, insurance companies and also households to buy national bonds.   

          IMPACTS ON BOND MARKETS
          Peripheral countries are still struggling with high volatility and prices are suffering as a result. In addition, negotiations over Greece’s debt have not yet been wound up. The IMF and the Euro group are urging banks and Greece’s government to rapidly conclude a viable agreement. The failure of these talks could trigger a default and increase creditor aversion to the eurozone.   
          Yields in core countries, which are considered as safe havens, are less and less attractive. 10-year yields in Germany are close to 2% and below that level in the US despite the loss of its triple A.
          Current yields in both countries are no longer a bulwark against inflation and real interest rates for
          some maturities are in fact negative.  
          Even so, the ECB’s benchmark rate is expected to stay low. Bear in mind that to buoy economies, most of which still have their heads under water, Mario Draghi’s first action on taking up his post at the ECB was to stop the rising cycle initiated by his predecessor.     
          The question overhanging banks is how to clean up  their balance sheets and help them finance the economy. To ward off a credit crunch, the ECB rode to the rescue, introducing a 3-year LTRO (Long Term Refinancing Operation) so that banks could  in their turn lend to small and medium sized companies and fuel the economic cycle (production – jobs – consumption).
          Investment grade and high yield companies still have abundant cash and low short term financing requirements so they can be expected to cope with adverse business conditions. As in 2011, corporate bonds –which outperformed other risk assets like equities and convertible bonds- should continue to present superior risk/return profiles in 2012. They have no significant debt refinancing ahead so there is no reason why they should default. Investors are automatically attracted to their substantial risk premiums and undemanding debt issuing schedules.


           

          Disclaimer:
          The data, comments and analysis in this bulletin refl ect the opinion of the Edmond de Rothschild Group and its affi liates with respect to the markets and their trends, regulation and tax issues, on the basis of its own expertise, economic analysis and information currently known to it. However, they shall not under any circumstances be construed as comprising any sort of undertaking or guarantee whatsoever on the part of the Edmond de Rothschild Group or its affi liates. All potential investors should consult their service provider or advisor and exercise their own judgement on the risks inherent to each UCITS and their suitability to the investors’ own personal and fi nancial circumstances. To this end, investors must acquaint themselves with the simplifi ed prospectus that is provided before any subscription and available at www.edram.fr or from the head offi ce of Edmond de Rothschild Asset Management. Data in this document is not contractual nor has it been certifi ed by the auditors. This document is for information only. Figures refer to previous years. Past performance is not necessarily a guide to future returns.

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