“Since the onset of financial crisis, the disparities between eurozone countries and USA have been accentuated. If exports-oriented countries, like Germany were harder hit by the crisis than the world’s largest consumer, USA, in the CEE region, countries with high consumption growth and major current account deficits have taken the heaviest blow”, said Gudrun Egger, Fixed Income Research Analyst at Erste Group.
Stimulus packages have been effective in dampening short-term losses of output, but in many countries this has resulted in governments taking over demand and indebtedness.
“The sharp increase in government debt is now at the epicenter of further downside risks to the global economy, as room for further stimulus is limited while consolidation efforts are likely to dampen growth”, the analyst said.
Interest rate cuts as of end 2010 most likely
If downside risks for the economy should grow to be more concrete and consolidation measures become increasingly difficult, this would lead to downside risks for the interest rate outlook and increase the likelihood of additional monetary support measures being implemented.
“From today’s perspective, we expect the Fed to start hiking rates at the very end of this year, ahead of the ECB (second quarter 2011) as the economic recovery should be faster in the US and the key rate is at a lower level”, said Rainer Singer, Erste analyst.
Sovereign debt remains a major problem
The sharp increase in yields for southern European countries seen recently is related to doubts aboud debt sustainability, even though speculation might have reinforced it. Indeed, in many countries looming deficits had their origin before the onset of the financial crisis. This leads to a situation where the fundamental analysis of country-specific debt figures gains importance for the assessment of quality of government debt.
Starting with an in-depth analysis of governments’ revenue and expenditure structure, Erste assesses the likelihood and effectiveness of different consolidation measures.
“As for debt dynamics, we must mention that more consolidation efforts will need to be implemented in the medium run, while at the same time, it is of uttermost importance to enhance growth. Because some countries will face hardships in achieving both”, said Singer.
Encouraging inflation would be a way to finance the debt, but it hard to put that into practice and brings about side effects, such as the increase in borrowing costs. “Therefore, we don’t think this is a feasible solution to solve the debt problem”, the analyst added.
Obviously, no country will be able to avoid budget consolidation, Erste specialists said. The difference however will rest in the magnitude of savings.
“Greece is clearly the negative outlier, while Spain and Portugal exhibit some similarities, implying that for these countries the market reaction might have been exaggerated, but is not totally justified. The feasibility and speed of a return to a sustainable path for these countries is questionable”, Singer said.
The US and France are somewhere in the midfield. Even though in the medium term there is a good chance for a return to sustainable dynamics, consolidation will certainly be necessary and should be initiated before markets might begin escalating pressure.
Germany on the other hand is a positive outlier with then figures confirming the reputation of the most solid government financing among the bigger states. In CEE countries, levels of public debt are still relatively low (apart from Hungary), but dependence on foreign funding makes the financing more vulnerable while global markets still have the jitters.
Upward trend for state bonds
“Solvency has started to deteriorate in some countries and we expect that investors will continue to seek high quality assets, although yields of highly liquid benchmark bonds (Eurozone for example), are already on extremely low levels. Once the uncertainty on financial markets abates, the yield curve should shift upwards as a whole”, analysts said.
Of German and US bonds, Erste analysts said they favor German bonds of the US Treasuries. In the CEE region, Erste recommends Hungarian and Polish bonds, which offer attractive risk/return relationships.
The current environment of low interest rates and improving fundamentals does no exert any pressure on the spreads. “However, for the medium-term development on the credit markets, we regard the sustainability of the economic recovery and the speed of the monetary exit strategy as the most important determinants. In terms of sectors, the volatility of credit spreads should remain limited amids a defensive industry. Many sectors have a stable outlook at the moment, and the improved liquidity has turned companies with solid credit profiles into interesting investment opportunities”, said Elena Statelov, credit analyst at Erste Group.
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