Signet’s Noel Mills argues for the re-emergence of high yield
Noel Mills, chief economist at Signet Group, a specialist fixed income asset management firm, believes investors should remain confident in the market for high yield debt.
The last four months of 2012 should prove to be an attractive trading environment for hedge funds, particularly in credit markets. The European Central Bank’s proposal to buy short-term eurozone bonds was a reaffirmation of previous messages and markets have reacted favourably. This happened previously with the Long-Term Refinancing Operations (LTRO) around the turn of the year. These interventions eased funding pressure on banks, yet also strengthened the tie between the sovereign and domestic banking system and thus increased the systematic risk in the eurozone.
Early in the crisis, the ECB, under the Securities Market Programme (SMP), intervened directly in the distressed bond markets of the periphery. This time, intervention – dubbed Outright Monetary Transactions (OMT) – is theoretically unlimited and is to be restricted to the secondary market and to sovereign bonds maturing within a one to three year time frame. The ECB emphasised that its intervention was to restore order to the monetary system, after the transmission mechanism between central banks and market interest rates had broken down due to Mario Drahgi’s term of “convertibility risk”. Most importantly, a prior condition for such interventions was that an economic stabilisation programme had to be in place.
Such programmes could take the form of a macroeconomic adjustment plan under the auspices of the European Financial Stability Facility or its successor fund, the European Stability Mechanism, or a precautionary programme under the Enhanced Conditions Credit Line.
The Germans were the dissenting voice on the ECB’s decision making board, arguing that it was akin to printing money (and thus inflationary) and it redistributed risks to member states tax payers. However, debt deflation is a greater risk and central banks can mop up excess liquidity. To satisfy German concerns, the ECB has promised to remove liquidity caused by its bond purchases by issuing short term securities to banks or calling on banks to park cash at the ECB. But more problematic are German fears of being the eurozone paymaster. The country’s political establishment accepted OMT
on the grounds that economic conditionality followed all future programmes. Meanwhile, global business surveys point towards deepening recession in Europe and a slowdown or stagnation for the rest of the world. This suggests global policy initiatives are required. If the OMT is successful in lowering market interest rates, in combination with the third round of quantitative easing in the US, global sentiment could further improve, even if OMT has a negligible effect on European monetary and fiscal policy.
A Chinese RMB1trn infrastructure package has also been announced. However, further policy initiatives are thought likely once the next Politburo takes over. Rising food and oil prices may place constraints on monetary easing in the emerging world. Brazil has cut interest rates by 5% to 7.5% but there has been little response from industry and – much like the rest of the world – may have to settle for lower growth.