«Spain seeking shelter under the rescue package and the optimum outcome of the election in Greece are failing to bring about any significant easing of the cycle of debt. Forecasts call for recession in most parts of the eurozone after the consolidation measures are implemented and with the deterioration of the important economic indicators,» reports Peter Brezinschek, Chief Analyst at Raiffeisen Bank International (RBI) in the Raiffeisen Research quarterly publication «Strategy Global Markets». Brezinschek expects eurozone GDP to fall to minus 0.3 per cent in 2012 and does not anticipate a return to growth before 2013 (0.8 per cent forecast).
The latest developments in the eurozone continue to have an impact on the government bond yields of periphery eurozone countries. «While German government bonds are still considered safe by investors, the yield premiums for Spain remain critical,» says Brezinschek. With regard to equities, Helge Rechberger, Head of RBI Equity Market Analysis, expects some respite now that the situation has eased temporarily in Greece and Spain.
In Brezinschek’s view, the call by some politicians for «growth instead of savings» is not the right way forward for the eurozone: «This provocative theory is fundamentally flawed since saving funds investments, therefore paving the way for long-term growth in the first place.» However, Raiffeisen’s Chief Analyst assumes that despite this, the EU will realize a compromise with, for example, project bonds for infrastructure or increased co-financing of structural and cohesion fund projects in the eurozone periphery countries.
Raiffeisen Research analysts believe that Spain’s funding requirement will rise to the top of the agenda now that the threat of an immediate exit by Greece from the euro is over. According to Brezinschek, France’s role will be particularly exciting: «It will become apparent in the coming weeks whether French President Francois Hollande will form a strong axis with Germany or emerge as a proponent of an alliance with Spain, Italy and the other periphery countries. This factional dispute will be decisive for the eurozone’s long-term focus.» According to the analyst, the first would be a guarantee for implementing a fiscal union that is based on stability and a tight framework — with a loss of sovereign rights in the event of violation of national budget requirements. The latter runs the risk of expediting the socializing of debt in the eurozone while neglecting to address the causes.
Raiffeisen’s Chief Analyst believes the eurozone’s core problems rest primarily with the fact that factors essential for a single currency union to function have not yet been implemented. «The material deficits lie with a single monetary policy and now 17 different economic and budget policies,» Brezinschek explains. However, he also criticizes the lack of flexible labor markets and different levels of competitiveness that are highly relevant to the divergence between the core eurozone surrounding Germany and the periphery countries. The economist expects the rescue packages and the European Central Bank’s (ECB) programs to remain legitimate as emergency actions, as long as structural reform measures are not adequately implemented or not yet market-effective. «However, the reform efforts will continue over and above 2013,» Brezinschek comments. «At the same time, we should also see fiscal consolidation in Europe.»
Brezinschek assumes that the ECB will provide short-term relief on the financial markets in the months ahead, too, either by lowering the deposit rate for the banks to at least zero per cent in order to mobilize their high liquidity buffer of EUR 750 billion with the ECB, through long-term refinancing operations (LTRO) or by resuming government bond purchases. «The latter is a strong option, so that Spanish and Italian yields can be lowered again. As we see it, a change in the main refinancing rate is unlikely, however,» the expert reports, who also expects an abundance of liquidity in the USA.
Brezinschek sees the easing of the threat of Greece exiting the euro, the Spanish issue and US monetary policy as a cocktail of factors that should maintain the stability of the EUR/USD exchange rate: «A range of EUR/USD 1.20 to 1.30 with a slight tendency toward the upper end therefore seems plausible in autumn. The Swiss National Bank (SNB) will continue to stick to the 1.20 minimum EUR/CHF exchange rate.»
German bond yields are at record lows. Maturities well in excess of ten years are the only segment across the yield curve to compensate for inflation. Raiffeisen Research analysts expect fluctuation around this low yield level over the summer months and assume that German bonds will remain in demand as a safe haven.
Against the background of the sharp increase in yield premiums on Italian and Spanish government bonds in the second quarter, market participants are focused once again on EU policy. «The recent extremely steep slope of the Spanish yield curve despite the provision of EU aid — with ten-year issues yielding well above 6 per cent — shows that the steps implemented to date by the politicians and the ECB are insufficient for a sustainable move of the market sentiment into positive territory,» Brezinschek explains. He sees little potential for the time being for Spanish and Italian government bond yields to move sustainably lower, since he believes the policies are unlikely to support investors’ hopes for a master plan.
According to Brezinschek, the market environment will only be attractive for corporate bonds with top-tier ratings. Furthermore, significant yield differentials between bonds from the core eurozone countries and the periphery nations can be expected. «Bearing in mind that we expect default rates to rise, we recommend that investors take a selective approach only,» Brezinschek states. Given the negative rating trends and in anticipation of rising default rates, the Chief Analyst does not expect any major spread-tightening in the coming months. «We expect investment-grade and high-yield corporate bond spreads to remain stable or rise slightly in the third quarter, so that our recommendation is neutral,» Brezinschek comments. In the course of the next twelve months, he expects risk premiums to fall moderately and gives a buy recommendation on a spread basis for both segments.
«US equity indices, in particular, held their ground on the stock markets between October 2011 and April 2012 and were more stable than their European or Japanese counterparts,» Rechberger states. He expects an environment that should foster positive sentiment on the stock markets in the third quarter through an easing of the crisis in the eurozone, further measures by the central banks to support liquidity and the first signs of stabilization of economic indicators. «A new or maybe the old US government will not have to concentrate more on consolidating the budget until after the election, which should then trim the equity markets’ potential again,» Rechberger explains, thus giving a buy recommendation for US equities.
In view of the still tense situation in the eurozone, the expert does not expect any disproportionate increase of the equity markets there in the weeks ahead. However, on the basis of the factors stated above, he anticipates a slight recovery of the most important indices.
With respect to sectors, the expert is clearly aiming for a cyclical positioning and therefore recommends overweighting the energy, financials, basic materials, industrial and IT sectors, as well as the cyclical consumer sector.
«Our portfolio is made up of 50 per cent equities, 5 per cent real estate and 45 per cent bonds,» Rechberger explains. This is due to a very balanced ratio of signs of recovery to outstanding risks, whereby he is aiming for a balanced positioning between equities and bonds. «The outstanding risks can be found primarily in Europe. Once one trouble spot in the eurozone is dealt with temporarily — for example, Greece’s exit from the eurozone — another comes to the fore, such as the Spanish banking problem. It is also difficult to find a way out of the crisis that is littered with numerous stumbling blocks,» Rechberger analyzes. According to the experts, the possibly temporary weakness on the US labor market and anticipated relatively high real economic growth of 2.2 per cent in Japan point to a temporary recovery of the market sentiment originating from these markets in the second half of 2012.
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