Trust in Draghi but tie your periphery, says Lombard Odier’s Ahmed
Salman Ahmed, strategist for Lombard Odier Investment Managers’ Global Fixed Income team on European Credit explains his team’s current negative view on European credit
Viewed in the context of Europe today, we believe that the markets are putting too much faith in Mario Draghi’s comments, from last year, that the ECB will do “whatever it takes” to protect the eurozone.
Although key metrics, such as current account and fiscal deficits, have improved in the periphery area, the main source of the problems (public sector debt to GDP) continues to deteriorate. By way of illustration, the latest EU Commission’s Autumn report showed that the public debt to GDP ratios of Greece, Spain, Italy and Portugal increased from 157%, 86% ,127% and 124% in 2012 to 176%, 95%, 133% and 128% respectively in 2013. In Greece’s case, the debt ratio is now reaching pre-private sector involvement levels.
So far, the policy of muddling-through, coupled with ECB’s liquidity provision and token German supported capital backstop, alongside tough austerity targets in the periphery countries, has helped to calm the cycle of crises, which took hold in 2010-2012. However, looking ahead, the key issue we see is that this austerity induced re-adjustment continues to be the preferred policy choice, which along-side further deterioration in public balance sheets, implies that political risks are likely to remain with us for the foreseeable future.
The continued deterioration of eurozone public balance sheets is one important reason for our present, negative view on European credit. While the markets’ trust in Draghi remains strong at this time, we think it is now prudent to “tie the periphery”, as OMT (Outright Monetary Transactions) in theory and in practice look to be quite different. Put another way, German support for OMT is likely to weaken if implementation probabilities rise and with debt to GDP ratios increasing, despite all the austerity induced adjustments, the outlook does not look rosy.