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Greek debt and bond bull market

10 March 2017

The Greek debt crisis has raised its head again recently. How long can the present "fudged" situation last?

Let me start my answer by highlighting that the Greek debt issues have never really gone away, each deal has simply kicked the can down the road a little further. Talks have been going on with the IMF and EU and there were suggestions that something could be done this month but it now looks as if it will wait a little longer.

We need to remember that the Euro is a politically driven project, and as such, the economic terms for membership were unfeasible from the outset. Greek debt, in relation to its economy, is large but in terms of the Eurozone as a whole is not huge. If holding the Euro together remains a priority, Greece can get a deal. There have been calls for debt forgiveness but with elections coming up, Mrs Merkel will be reluctant to be seen to be giving hard earned German money to Greece.

Greece is at the forefront of the refugee crisis and is adding pressure on its economy. The rest of Europe needs to help Greece control the flow and to meet its obligations on the agreement with Turkey. At this time, another deal is likely to be worked out to kick the can down the road a little further. How long can they fudge the deals? If the will is there it appears, indefinitely. The bigger risk to the Euro project could come in the French election which is not our expectation but after Brexit and Trump cannot be ruled out. If Le Pen is elected she will likely begin her campaign to exit the Euro. Unlike Brexit, there is no mechanism for anyone to exit the Euro and a French attempt to exit the Euro would be much more problematic than Greece.

Is the thirty year bull market for bonds finally coming to an end?

Interest rates, having reached zero or negative in many parts of the world, mean that it is hard to see the thirty year bull market going much further. However, that is not to say that we will see a reversal of the last thirty years, nor does it mean that we are necessarily going to see an extended bear market in bonds. Any sell off in bonds may be, relative to the thirty year bull market, short-lived.

Interest rates have started to move higher in the US but we expect it will be some time before we see rate rises this side of the Atlantic. While UK inflation is moving higher in the short-term and in the first half of this year, we may exceed the Bank of England 2% target, it is likely to fall back below target in the long run. As we have outlined in previous CIO questions, much of the recent inflation rise is due to Brexit and the rise of oil prices, events that are unlikely to be repeated.

High sovereign debt levels and precarious growth prospects will mean governments and central banks may be reluctant to see interest rates rising rapidly. There remain many deflationary forces as a result of technological innovation and ageing populations, meaning that inflationary pressures may be contained for some years to come. While we expect rates to eventually rise in the UK, as they have in the US, we believe that the next peak in rates will still be lower than the last. As with many things, the path of UK interest rates is likely to be impacted by Brexit negotiations. A slow down on a bad Brexit could lead to further stimulus from the Bank of England, which would take bond yields lower again.

As markets move to price in expected rate rises, bonds may still have attractions for those looking to balance investment portfolios. Careful timing and exposure to the right parts of the yield curve will be important.


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