On the other hand, the economic outlook is bleak for Eurozone. Economic activity is very weak with GDP figures at -4.5 % in 2009 and around 0 in 2010. This means that with ECB rate at 1 %, the interest rate hierarchy will be between 1 % and 3.7 % maximum for the 10 year German government bonds.
As far as growth is weak, the risk of higher rates is very low for a long period of time. In the second half of 2010, we can expect a better shape for economic activity. At this moment, only, interest rates from the 2 year to the 10 year will converge to 4 %.
So in the next 12-18 months, we imagine a 2 step process. One until the end of 2010 first half with stable interest rates from the ECB and bonds rates fluctuating but not too far from the range 1 – 3.7 %. After next spring, we expect a better shape for economic growth and a convergence of interest rates to 4 %.
e-fundresearch: Do you expect deflationary or inflationary developments in Europe in the next 12 months?
Wächter: Looking at price developments, there is 2 or 3 important points
- With weak growth, pressures on the good market will stay very low. This will not lead to higher prices.
- We know that central banks have an anti-inflationary commitment. This means that we can imagine accommodative policies as temporary not permanent. They will not allow high inflation on the long term.
- Nevertheless, in the short run, commodity prices, even in world with low growth, are high and could trigger a period with inflation rates higher than expected.
My point is that real weak economic condition will not allow higher inflation.
As growth will be negative for the next 3 or 4 quarters, there is still a risk on deflation in Euro Zone..
e-fundresearch: How do you assess the development of the national debt in Europe and which impacts do you expect for the money and capital markets?
Wächter: In a recession, behaviors change. Risk aversion means that saving is higher and flows of new debt are lower for private economic agents.
With this higher private saving, governments have to increase their debt.
If they don´t, risks on growth are higher than now and risks of deflation are also higher. Higher saving from private economic agents means lower global demand. This has two effects – One is lower activity, which means hard downside adjustments on the labor market. The other effect is price adjustment with lower prices to find equilibrium, even on the labor market. In that situation, the risk of deflation is very high.
Higher public debt will help to absorb this excess of saving, limiting the risk of lower activity and of deflation. In that way, and in the short run, higher public debt is virtuous. With all this saving, there is no real risk on interest rates.
In the medium run, we have to think on public debt in another way. Economies have had a very negative shock. Governments have to boost activity to avoid a depression. They have to finance these stimulus plans with new debt. Repayment will be done later. This means that it will take 10 or 15 years to totally absorb this negative shock and it will take 10 or 15 years to have a public debt to GDP ratio comparable to what we had before.
Public debt has to smooth the adjustment during a negative shock.
e-fundresearch: Which segments and/or emitters are currently overweighted or underweighted in money market funds? What are the reasons for it?
Schatz: In the current recessionary economic background, our investment policy for money-market funds is to favour issuers for which we perceive the highest credit quality. To assess the credit quality we shall rely on two main factors:
- intrinsic quality depending on balance sheet strength as well as the resilience of free cashflow to an adverse economic environment;
- whether or not the issuer may be regarded as systemic and hence enjoy government support if need be.
Another factor is the capacity of an issuer to provide good quality information with reasonable timeliness.
According to the above rationale, we currently tend to overweight:
- Senoir debt from large retail banks based in large European countries for which we expect government support.
Our assessment of governement support will vary according to the various countries and institutions: existence of a government-backed financing window, whether or not the government has already provided financial support to the issuer itself or similar issuers, size of the bank etc. … Even if we think that governement support is likely, we would still exclude banks with a high exposure to very recesionary areas like southern Spain, Baltic states, some Eastern European countries etc. … We would also not want to gain exposure to banks based in jurisdictions for which we think that the country is too small or its budget deficit is too high.
- Large utilities in various businesses like electricity, natural gas, or others, where cashflow resilience is expected to be strong.
- Large telecom companies with good free cashflows. Cashflow from the telephone or data businesses is certainly less in a recession than in good economic times, but it is rather resilient. Also, capex can be lowered in order to preserve free cashflow.
- Large food or consumer staples conglomerates with strong balance-sheets and good international diversification. Of course, special analysis has to be carried out to make sure that their product mix is consistent with consumer demand in the current difficult environment. Large pharmaceuticals may also be included.
Conversely, we will tend to underweight issuers whose business is cyclical or dependant on big-ticket items: that would include the auto industry (manufacturers and suppliers), chemicals, machinery manufacturers, some retailers. We would finally also underweight commercial real-estate issuers as the value of their assets has come down a great deal.
In any case, an in-depth assessment for each and every issuer to be included in our portfolios will be carried out by an in-house specialised credit analyst in order to exclude those issuers which may have special problems, even if they belong to an "overweight sector".
Once an issuer may become eligible, constant monitoring is also in place by both our credit analysis and risk departments in order to react swiftly to any adverse piece of news.
e-fundresearch: Thank you for the interview!
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