2013: ECB will become Europe’s single bank supervisor, RBS predicts

As 2012 closes, credit markets are torn between two opposing forces, and in 2013 European policymakers will get closer to a solution, stepping towards a banking union, according to Alberto Gallo, head of European macro credit research at Royal Bank of Scotland.

The two forces are central bank liquidity, strong demand and negative net supply support credit on one side and negative growth, capital flight and financial fragmentation which will undermine the real economy and are slowly isolating the periphery from core countries on the other.

“Despite the fundamental challenges, we think European credit offers some of the last oasis where fixed income investors can generate sizeable returns. We are long financials; high yield; UK; semicore Europe as well as Italy, Ireland and Portugal in the periphery,” Gallo said in its its outlook for the new year.

In this scenario, in 2013, the European Central Bank will become Europe’s single bank supervisor, easing pressures on bank bonds. This trend will be opposed by core countries resulting in a slower progress then expected.

Europe continues to run at two speeds: “ECB liquidity policies reduce tail risk, but cannot stop the Benjamin Button syndrome of financial fragmentation. The periphery is becoming increasingly isolated, as companies there pay twice as much to borrow than others elsewhere and bankruptcies break record highs,” Gallo warned.

Despite this scenario, in 2013 credit will perform well as easing policy and strong demand/supply technicals will overshadow these challenges.

“We forecast 4% total return in IG and 9% in HY, where defaults will stay low at 3.5%,” the analyst said.

Gallo also shared some views on key European countries.
Ireland is on a slow path to recovery and will benefit from restructuring its promissory notes. Meanwhile, Portugal will miss its targets, but will continue to enjoy IMF support.

“We see low risk of a Greek exit in 2013, consistent with today’s IMF/ECB deal. Italy is set to see rising political fragmentation and social unrest around April elections, but eventually Monti will stay. We are long peripheral banks as well as utilities, telecoms and industrials,” he said.

France and Holland are far from the periphery. According to Gallo, they have time to address their challenges and will continue to perform well, on strong access to capital markets and reduced asset risk across banks. The UK and its banking system will benefit from early deleveraging, supportive policy and the new BoE governance.

Finally, Spanish sovereign debt is unsustainable, as the central government continues to support banks and regions.

“We expect Spain to request aid in Q1 2013. The US and Australia are entering a phase of re-leveraging. With record-low yields, growing balance sheets and shareholder-friendly activity, there is less upside left for bondholders,” RBS said.


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