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Bonds withstand crisisbut face exit dangers
Filed under NewsDec 5PARIS – Government debt and so-called “exit strategies” after the crisis are set to be the big issues on bond markets which have so far bypassed fears of a leap in yields for countries with big budget deficits.
For some time, analysts have warned that widening government deficits and inflation, likely consequences of huge crisis stimulus programs, could generate great tensions on government bond markets.
The worst has not happened; but the markets are on edge and want to see credible “exit strategies” to wind down stimulus, deficits and debt, and contain inflationary pressures, for next year.
Despite, or in some cases because, of the extraordinary aversion to risk at the height of the financial crisis, bond markets have had a solid year, rising strongly when risk aversion was at its highest, and then holding up even as economic recovery began.
Investors are still attracted by emerging markets, which in general are considered better positioned to emerge strongly from the global crisis than developed countries, analysts said.
But the debt crisis in Dubai has focused concerns on the strained state of public finances in euro zone member Greece, and it has also been a wake-up call on bond markets regarding governments deficits and debt in general.
“Exit strategy is the big theme of 2010,” said Nicolas Forest, head of fixed income strategy at Dexia.
Governments sell bonds with a guaranteed fixed income to borrow money to cover their budget deficits. Their bonds have a credit rating, according to how “safe” they are judged to be.
But if interest rates for that category of risk in general rise, or if the perceived risk of a countrys economic situation or inflation rises, some investors will sell the bonds, thereby pushing up the income as a percentage of the price.
This tends to change the overall level of rates in that country, and then stocks usually tend to fall because economic activity will be constrained.
Analysts point to the lesson of 1994, when the US Federal Reserve raised interest rates, triggering a fall in the markets and a rise in bond yields.
Central banks have tread carefully this year, by maintaining easy-money policies to prop up fragile economies.
On Thursday, the European Central Bank kept its main interest rate unchanged at a record low point of 1.0 percent and announced it would begin to unwind crisis easy-money measures on December 16.
The ECB decisions announced Thursday are “very much consistent with only a gradual phasing out of its unconventional measures,” said Nicholas Kounis at the Franco-Belgian-Dutch bank Fortis.
Meanwhile, although ECB governors were wary of signaling an all-clear on the economic front, ECB chief Jean-Claude Trichet also warned against exaggerating the effects of the crisis in Dubai.
“At the same time we have to consider the impact that a relatively modest event had on the markets,” he added.
Although the Dubai situation is now seen by many observers as an essentially local problem, it initially rocked financial markets and focused concern about other heavily indebted countries, such as Greece. – AFP
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