A Happy New Year? EuroWeek weighs the odds
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A Happy New Year? EuroWeek weighs the odds

The dawn of 2012 brings new hope — and new fears. The sense of foreboding in financial markets is pervasive, but sentiment is self-fulfilling. Investors, bankers and funding officials alike must approach the year with determination and calmness, or the troubles besetting markets will only get worse. There are many good reasons to feel confident, as well as to worry. EuroWeek highlights five of each.

On the up side...

Europe’s crisis

It may be a surprise to see this top of the positives list, as fear of the future and austerity are about to generate a second recession. As the downturn bites, it will severely test confidence in government bond markets, as well as risk assets. Yet the position now is surely better than a year ago. In 2011 govvie investors faced up to demons they had buried deep in their unconscious. So did Europe’s politicians. Longstanding fiscal and structural problems are now being dealt with. The road will be long, but at least the denial phase is over. (It’s not in the US, but that’s another story...)



Bank funding

The next biggest scare du jour is bank funding, with dire predictions that billions or trillions of debt may be unrefinanceable in 2012. Get a life! Banks have managed so far without the senior term bond market, using a combination of deposits, covered bonds and ABS, money markets and central banks. They will continue to do so. The authorities will not let swathes of banks collapse.



Corporate fortresses

Companies are heading into what will probably be a recession in Europe and global slowdown. Shares may fall, yet corporate failures should be limited. Firms are still in storm defence mode after the 2008 crash, with pots of cash and moderate leverage (outside the private equity world). Above all, they seem to have cracked the secret of how to make junior employees feel most of the pain of economic distress, while keeping profits fat. Weak sectors like directories remain vulnerable, but most are fighting fit.



Infrastructure investment

Don’t see this as a cure for recession. Projects take years to plan and plenty of financing mechanisms already exist, so a bumper harvest cannot be created at the wave of a finance minister’s wand. But there are barriers of regulation and habit that have inhibited funds’ investment. Action from governments would help economic confidence, even if the fruits are modest and take time to arrive.



Retail hungry for bonds

A smaller fillip, this, but Europe’s retail bond markets are thriving. From the UK to Germany and Belgium to Italy, private investors have been thrilled to pump cash into companies and banks for a fixed yield much better than deposits, even when institutional markets were dysfunctional. Price transparency, as in the UK, helps a lot. Germany’s market holds a danger, though — much smaller firms issue here and the default risk is real.

Night terrors...

Deleveraging

With funding scarce and more capital demanded, banks will cut assets where they can. Morgan Stanley forecasts €1.6tr-€3tr of deleveraging risk by European banks in the next couple of years, putting up to €1tr of funded loans at risk. Before you despair, remember that is only 3%-5% of loans in Europe, and plenty of companies will not mind reducing gearing. Investment grade firms should be fine — they will get loans, and can keep moving their debt into the bond market. Things will be tougher for SMEs, but ultra-low interest rates mean debt conditions are still bearable. Highly indebted businesses may feel the pinch keenly.



More scandals

This is a racing certainty. Markets are so big and complex, and rewards so huge, that naughtiness will always occur. Kweku Adoboli and MF Global proved in 2011 that blow-ups never happen where you expect — although afterwards, everyone says “of course”. A year from now the Hall of Shame will have new entrants.



Inflation

Economists seem convinced deflation is the one to worry about. But so they have been since 2008. Have they tried to buy a can of tomatoes recently? EU inflation never got lower than 1% in 2009; in 2011 it was 3.4%. Cheap Chinese labour is no longer weighing so heavily on prices and the long term commodity story is still bullish. Sadly for savers, fixed rate bond yields offer scant protection against inflation.



Methane plumes

Politicians will continue to duck their responsibility to tackle climate change, despite mountains of evidence that it is accelerating. If you’re thinking “this is so 2007”, google “methane plumes”. If you’re surprised, feel guilty – it was all predicted. Ironically, the corporate sector sees opportunity here, but governments are being cowards. Tell them to get their act together!



War with Iran

The nastiest immediate threat is the head-on collision looming between the US, Israel and UK on one hand and Iran on the other. The West seems determined to forget that it has a massive nuclear deterrent and go to war rather than let Iran get the bomb. The Iranians show no signs of backing down. War would surely mean radiation being released, as well as heavy casualties on both sides. The best thing that could happen in 2012 would be a resolution to this crisis.

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