Cassandras against the consensus

  • 01 Jun 1998
Email a colleague
Request a PDF

Yes, credit will be king in euroland. But don't forget market forces. Some investors argue that supply and demand imbalances could create much larger yield differentials among EU governments than most people expect.

CONTRARIAN views on the impact of the euro on fixed income investment are few and far between. Neil Record, who heads up Record Treasury Management - currency overlay specialists - is one of the most distinctive voices.
His doubts stem from a fundamental scepticism about how the euro will work. The refusal to accept the possibility that countries may leave the system is, he argues, like building an aeroplane with no emergency exits.
Once anyone begins to think about that possibility, however, then assets in those countries where there is the risk of a "bad" exit - one followed by the return to the previous currency at, say, a 20% discount to the old central rate - begin to attract a risk premium.
Given the freedom to move assets and liabilities around euroland, the tendency should be to put assets in putatively strong areas and liabilities in putatively weak areas.
The result of this, says Record, "is that I expect excess demand for German assets and excess supply of Italian liabilities".
There is no reason to suppose that the German authorities will want to issue more bonds to soak up demand or, indeed, that the Italians will be able to buy up liabilities. "The result will be that an interest rate differential will open up that is unrelated to credit quality," Record argues.
Taken in isolation, that statement does not diverge from the consensus. Record differs from conventional asset managers, however, in the scale of the divergence he predicts and in the period within which he expects it to emerge.
"Let's assume that the Italians begin to loosen the corset within six months," he says. "The Germans will protest, but the Italians will have very little room for manoeuvre and it will be apparent that they will soon be completely at loggerheads.
"Once that happens, people will begin to think that an exit is possible over the next couple of years with Italian interest rates going to 9%."
At that point, Record argues: "If there's 20% chance of exit in the next 12 months and another 20% chance in the following 12 months, and an exit would imply a 20% devaluation, then there's a 4% break-up premium that investors will need just to stay economically neutral if they invest in Italian bonds of any credit quality."
That size of premium would take euroland back to its pre-convergence spreads.
Record is not alone in sounding a warning note. Nick Horsfall, senior investment consultant with Watson Wyatt, says: "Our view is that the risks of the euro have been very much underplayed and everyone is just looking at the good news, not the risks that some of the economies won't like the pain they'll have to go through."
If this break-up premium fails to materialise, Record believes it will be because of government or ECB intervention to prevent it - evidence of which it will be possible to detect in increasing money supply and other flows to neutralise movements from Italian assets into German ones.
Record's own treasury management operation provides forward derivatives programmes to give investment managers protection against currency movements once they have selected their portfolios. He sees his task over the next six months as the "education" of clients to appreciate the fundamental dangers of Emu.
As Record argues: "The high point of European political union was the acceptance of the Maastricht Treaty. In retrospect, the high point of European monetary convergence will be seen to have been mid-1998."

  • 01 Jun 1998

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 30,363.50 109 7.56%
2 JPMorgan 27,423.07 94 6.82%
3 Goldman Sachs 27,365.68 53 6.81%
4 Barclays 25,009.79 63 6.22%
5 Deutsche Bank 22,679.02 69 5.64%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Mizuho 299.85 1 21.73%
1 ING 299.85 1 21.73%
1 Commerzbank Group 299.85 1 21.73%
1 BNP Paribas 299.85 1 21.73%
5 UBS 60.22 1 4.36%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Goldman Sachs 1,607.28 5 22.59%
2 Credit Suisse 1,301.65 4 18.30%
3 UBS 970.80 3 13.65%
4 BNP Paribas 522.35 4 7.34%
5 SG Corporate & Investment Banking 444.17 3 6.24%