You will have noticed that equity markets have rallied in recent weeks. This is due in part to the European Central Bank (ECB) firing its “big bazooka” at the end of December, with unprecedented buying of government bonds and injecting liquidity into the financial system. The result has been a very large reduction in sovereign bond yields, notably in Italy and easing of bank funding pressures. At the same time positive economic data from the US including falling unemployment has cheered the markets. However frequent comments have been made that central bank and government fiscal measures to address the EuroZone debt crisis has merely been kicking the can down the road, meaning the symptoms, such as liquidity and access to credit are being treated not the underlying causes. There is simply too much government debtedness which will not go away overnight.
The UK has just been placed on negative watch by Moody’s with a risk that its coveted AAA credit rating faces a potential downgrade in the next 18 months. However the UK is in a stronger position than many developed economies for various reasons. Firstly much of our debt, in the form of government bonds or gilts is long dated and therefore the UK does not face short term refinancing pressures like other economies. Secondly there is more scope in the UK for the use of “financial repression,” which are processes designed to keep bond yields low. An example of a tool for this is Quantitative Easing (QE). This reduces the cost of government borrowing, making debt repayments easier and also contributes to inflating an economy out of debt. Despite the UK’s safe haven status the key problem with the UK is anaemic economic growth.
To date the crash in global stockmarkets that I feared in the autumn has not materialised. However given the observation above that the underlying causes of the EuroZone debt crisis have yet to be addressed the capacity for a shock remains. Right now I am happy to remain in cash although I am pondering other low risk assets for my pension funds.
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