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Fear and Hope Divide Investors Ahead of EU Summit

Monday, 25 Jun 2012 07:25 AM

 

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Investors are approaching this week's crucial European Union leaders summit braced for disappointment but keen to put money to work on any signs of a unified and comprehensive plan to tackle the region's 30-month-long debt crisis.

Wealth managers and analysts say no one really expects the meeting on Thursday and Friday to produce the definitive solution. A credible plan supported by all nations with a realistic implementation time line, however could start to bring investors back.

"It's very painful for professional investors and retail investors to hold cash and bonds in this environment when you look at inflation," said Lorne Baring, managing director of Swiss asset manager B Capital Wealth Management.

Baring said investors would prefer to be owning strong international companies that have cash-rich balance sheets and pay good dividends.

"But they are held back by headlines created by the inactivity of politicians," he said. "It's just wiping trillions off the value of equities globally and, frankly, unnecessarily so."

Analysts at Barclays Bank said investors wanted to see three things emerge from the summit: a roadmap to fiscal integration, moves toward better supervision of the region's banking sector, and measures to revive economic growth.

"I don't think many people really expect a silver bullet to be delivered. People have realized that there is no easy solution," Laurent Fransolet, head of European fixed income research at Barclays Capital, said.

But he said with short-term Italian debt offering yields of around four percent versus safe haven bonds and similar assets at close to zero returns, if some progress was made people would start to think about buying.

"If you really curtail the tail risk then it makes it a little bit more attractive," he said.

However, he also cautioned: "The nervousness in these markets and the risk aversion is going to be exceptionally high even if we get some relief in the near term."

CENTRAL BANK BACKSTOP

Equity investors have been generally resilient to the cycle of crisis in Europe this year, clinging to a view central banks will continue to manage the world economy and limit the impact of Europe's problems on global growth.

World stocks as measured by MSCI's main global equity index are up 1.2 percent year to date and the widely tracked S&P 500 index of U.S. stocks has gained 5.4 percent.

But these gains are mainly due to the assistance already provided, signs central banks remain ready to act, and forecasts that growth outside Europe will persist this year due mainly to activity in emerging markets like China.

Although disappointment that the U.S. Federal Reserve did not go further to counteract growing signs of a slowdown in its economy at its most recent meeting dented some of this optimism in the past week.

Barclays' latest global outlook forecasts the world economy will grow by 3.5 percent in 2012, in line with most other major forecasters, and by 3.9 percent in 2013 despite a downward revision to growth in the United States.

Hopes among some that the European Central Bank could step in with a rate cut at its next meeting in early July could get a boost from the release the euro area's harmonized index of consumer prices (HICP) on June 29.

The inflation reading is expected to be stable in June after falling to its lowest level in over a year in May at 2.4 percent, due to a big fall in energy and commodity prices.

The index may even fall further given the weakness in energy prices this month. The price of Brent has fallen by around 7.5 in the past week and has slid by about 30 percent from its 2012 high of $128.40 reached in March.

Data on bank lending to the private sector and growth in the M3 monetary aggregate, both for May, could also fuel expectations of a rate cut as these have been slowing since the central bank ended a program of massive liquidity injections into the banking system.

The ECB released over 1 trillion euros in cheap three-year loans (LTROs) to banks in December and February, taking the heat out of a feared credit crisis in the first quarter of this year.

Many economists now expect a cut in interest rates at the ECB's next policy meeting on July 5, an option several policymakers have also mentioned since they were left unchanged at the June 6 meeting.

Europe's peripheral bond markets will be focused on Italy's sale of zero-coupon and inflation-linked bonds on Tuesday and medium- and longer-term bonds on Thursday. Spain is also due to sell three-and six-month Treasury bills on Tuesday.

Both Spain and Italy are finding it increasingly hard to finance themselves in bond markets and still have a lot of money to raise to meet their funding requirements.

Italy's 10-year government bond yields are currently around at 5.80 percent with equivalent Spanish debt at 6.55 percent.

Their Treasurys will both be hoping that European leaders do enough at the upcoming summit to encourage buyers.

© 2014 Thomson/Reuters. All rights reserved.

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