Euro Currency
The problems of the banking system won’t be solved without radical reform, which is fiercely opposed by vested interests and their supportive political elites. Repeated doses of “morphine” – easy credit – will be required to prevent financial explosions.
The problem of sluggish economic growth won’t be solved either, given policies that favour stasis rather than stimulus (or the most inefficient and therefore ineffective types of stimulus), and political resistance to radical restructuring. Again, the answer will be… more “morphine.”
The strongest sovereign bonds will remain one essential component of a low-risk portfolio for a long time to come. They will only become risky when central banks start raising interest rates in response to rising inflation. That will happen eventually, but now it’s not even on the radar screen.
Corporate bonds won’t necessarily perform as well. Companies’ creditworthiness is sensitive to the strength of their profits, and their balance sheets are leveraged. So when economies perform poorly, risk aversion rises, motivating investors to move out of higher-risk corporates into lowest-risk sovereigns. Values of the two classes can move in opposite directions at times of elevated stress.
There can be other factors that raise yields/depress values of corporates. In Europe, for example, stressed banks are focused on reducing the overall riskiness of their assets, so they become less ready to hold corporate bonds.
Barclays Capital argues that yields on the strongest sovereign bonds are likely to remain extremely low for a very long time because of the serious shortage of “risk-free” assets relative to demand.
The pool of high-quality bonds has contracted because so much of what used to be rated as safe is now regarded as high-risk – US mortgage agency debt, structured credit, sovereign bonds of the Club Med nations.
Demand for the highest-quality stuff is strong, keeping down their interest rates, because:
- Investors are frightened of defaults, given dangerous stresses in the global financial system and the prospect of sluggish economic growth;
- Both prudence and increasingly tougher regulatory requirements mean that long-term savings institutions are shifting the balance in their funds away from equities, into the safest bonds;
- Central banks are buying bonds with their “printed” money to depress yields – a process dubbed “financial repression,” as it robs savers of fair returns.
One way that retirees have sought to counter the devastating squeeze on their incomes is to invest in the higher-yielding bonds of companies, public authorities and emerging economies.
However, higher yields always mean higher risk.
this article follows on from – Investing in Bonds: Is It Crazy?
CopyRight – OnTarget 2012 by Martin Spring
