A broadly positive outlook for 2014 doesn’t
necessarily mean investors exit the fixed-income market as Friday’s data (a sharp drop in Spanish unemployment claims in December) showed Spanish government bonds could do relatively well compared to the core countries, said Georg Grodzki, Head of Credit Research at UK’s Legal & General Investment Management.
The peripheral government bonds should offer some good opportunities though investors should be cautious as risks in the government bond markets will probably rise during the course of the year due to buoyant economic data.
Central banks will face challenges when they try to ensure yield rises are orderly and not sudden and steep. Spanish government bonds may deliver negative returns at a future date as well. However, if investors are looking for opportunities in the short-run, being overweight in peripheral government bonds may be a good idea, he said.
Asked if investors need to worry about inflation in 2014, Georg said inflation risk is currently not on the horizon. As long as energy and commodity prices remain benign, a spike in inflation looks unlikely.
Also wage increases are hard to come by in Europe. There are some tentative signs of a wage increase in the US, but that’s unlikely to translate into a price-rise spiral in 2014. So central banks will potentially come across a benign set of parameters in 2014, and they can justifiably keep interest rates low for longer periods in the absence of inflationary pressures. If asset prices didn’t go through the roof, there was no harm in keeping interest rates lower, he argued.
Asked if he’s willing to allocate fresh funds in credit products after the incredible bull-run in the fixed-income markets, Georg said it’s difficult to justify an overweight position in investment-grade securities at this juncture.
Credit spreads have not narrowed to the ridiculously tight ranges of 2005-2006, but they are not far off either. If it was not for financials, particularly banks, credit spreads would have been equal or lower than the all-time lows witnessed in the pre-2007 era.
Additionally, if one considers the higher rate of corporate mergers and acquisitions – share buybacks that are spilling over from the US to Europe, there’s no reason to be bullish on credit products since they have resulted in higher leverage for companies. Nevertheless, default rates are likely to remain low; and with a favorable global economic forecast for 2014, cash flows are likely to remain robust as well, Georg observed.
Asked to comment on the options left with the European Central Bank to spur lending in the currency region, Georg said the ECB is not left with too many options in its current toolbox. Buying government bonds will not spur lending by banks. Another round of LTRO will not necessarily help banks to lend more because banks in the region are not constrained by funds.
Banks are still reluctant to lend to corporates while corporates are cautious about seeking additional loans. Banks have no trouble funding themselves, even in Spain and other peripheral countries, although credit spreads continue to tighten at both senior and subordinated debt levels.
The impending Asset Quality Review and stress tests by the ECB are possibly holding the banks back from lending because no self-respecting commercial-bank chief would like to be marked for recapitalization. Hence lowering interest rates and increasing liquidity by the ECB is unlikely to make any difference to commercial lending, he concluded.
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