LONDON | In a report to investors in London, Newton Global Dynamic Bond Fund, which is part of Bank of New York Mellon, noted that political decisions taken by the European Comission regarding the euro crisis are a source of worry for the markets. In fact, plans to tackle weak economies in the periphery may be raising the chances of default.
Newton GDB Fund said that its portfolios have increased exposure on emerging markets to diversify currency risks rather than expand euro peripheral debt holdings in spite of their attractive yields.
“We remain concerned about the approach to the euro zone crisis,” the report explained, “which subjects already weak economies to fiscal austerity. A prolonged period of recession in parts of Southern Europe will continue to shift the emphasis of the crisis from one focussed on liquidity to solvency concerns.”
Analysts at the fund reminded authorities that programmes to cope with the negative effects of deleveraging can have a significant influence over markets’ behaviour, especially in the short to medium term.
“Whether these authorities resort to the maintenance of very low interest rates, money-printing or default, all such possible responses have caused significant concerns among investors, and have changed the fortunes of global bond investors.”
Paul Brain, manager of the Newton GDB Fund, said that fixed income markets have undergone wide changes over the last three years. Tight fiscal policy may seem supportive of fixed income markets, as it results in low interest rates and also helps to keep a lid on inflation, but its consequences can be the opposite. Brain highlighted that
“such an environment is disruptive, as it raises the possibility of default by both companies and governments.”
Although Brain envisages a euro zone with a reduced membership in the future, in his opinion the damage would be limited to Greece and there would be no contagion effect to bigger economies.
“While we believe, ultimately, that investors in Italian and Spanish government debt will be spared a ‘haircut’, we think that we may be likely to see Greece exit the single currency, as well as a Portuguese capital impairment (a reduction in the payments due to investors in the country’s government bonds),” he said.
The Newton GDB Fund experts admitted that concerns have, more recently, been offset by the provision of capital through central bank operations like the European Central Bank’s ‘LTRO’ (Long-Term Refinancing Operations). But, while disaster appears to have been averted, the liquidity these funds have provided seems to be flowing into financial assets instead of the real economy, they warned.
“We expect the current strong appetite for risk to continue at least until the effects of the most recent LTRO programme have worked their way through the system.”