31.01.2012

By Simon Miller

The key story in 2011 was the sovereign debt crisis in the eurozone and this is set to continue into this year as countries face raising billions of euros worth of debt in a market that is suspicious about whether the debt can be met.

RBC Capital Markets analysts estimate that €230 billion (£190 billion) of
European government bond supply had to be raised in the first quarter of 2012 alone and the reaction of the markets so far has been one of caution.

On 4 January, Germany sold €4.1 billion of 10-year government bonds and attracted bids of €5.3 billion with a yield of 1.93 per cent.

Although it was an improvement on November’s auction, where over a third of Binds went unsold in an auction of €6 billion of 10-year debt, the bids exceeding 1.3 of supply was a relatively low take up which could possibly reflect a fear of retraction in the eurozone hitting Germany.

The same reluctance was seen in France where nearly €4 billion of debt was sold at an average yield of 3.29 per cent. Although it was seen as a relative success, the bids exceeding supply plummeted from 3.05 to 1.64.

However, according to Ranvir Singh, CEO of market analysts RANsquawk, the take-up in France could reflect a divergence between the eurozone’s big two Germany and France.

He commented: “For the cameras at least, the Merkozy [Angela Merkel and Nicolas Sarkozy] double act makes much of fiscal discipline and solidarity across the Rhine. Demand for Germany’s bunds remains as solid as ever. The question marks raised after a technically uncovered bund auction in November appear to have gone.”

He added: “But French yields are rising as markets continue to fret about the Paris government’s ability to pay its debts. An auction of 10-year bonds on [5 January] offered an average yield of 3.29per cent, up from the 3.18 per cent offered at a similar sale in December.

"A long way from the punishing borrowing costs paid by Spain and Italy, but arguably a step closer to a credit rating downgrade.”

The concerns of the debt markets reflect the growing sense that the
eurozone will be heading into an unavoidable recession.

According to John Chatfeild-Roberts, chief investment officer at Jupiter Asset Management, 2012 will see Europe’s crisis rumbling on and that while predicting the final outcome was very difficult, “further financial blood-letting” would be required before the global economy could heal.

In a briefing note, Chatfeild-Roberts added: “European politicians have treated this as a crisis of liquidity – a temporary shortage of cash – rather than one of solvency, where countries’ finances are unsustainable. As a consequence, the woes of the single currency zone could take a heavy toll on world growth. If there is a recession on the continent, the UK will not be immune from the knock-on effects.”

In his weekly briefing, chief investment officer at EMEA Merrill Lynch Wealth Management Bill O’Neill noted: “A persistent failure to address the
systematic issue in the eurozone debt crisis – the risk of default - means Europe will see a contraction in activity this year. We clearly need to see the European Central Banks’s aggressive approach in its latest refinancing operation (which allocated €589 billion) being built upon through confidence in budget programmes put forward by the Spanish and Italian governments, as well as the fiscal compact being drafted by March.”

Carmignac Gestion investment committee member Didier St Georges warned that the seriousness of the European crisis could be analysed as the combination of two incompatible circumstances: public debt at unsustainable levels, and a banking sector that is so under-capitalised that it could not recognise the full extent of this hole in its balance sheets.

He said that the debt issue was getting worse. Pointing to Portugal he said the country faced a 4.2 per cent of GDP in debt interest, a 1.5 per cent deficit and a shrinking economy. As a result it faced 2012 7.7 per cent away from a balanced budget which would enable it to start paying off its debt.

“In varying degrees, most European countries are in this position, which will therefore worsen with the economic downturn,” commented St Georges.