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Global Fixed income markets • Soo Boo Cheah, CFA • Suzanne Gaynor
The short-term fixes rely heavily on
the ECB and member assistance that
comes with high political hurdles.
The long-term solution is to gain
economic competitiveness via internal
devaluation within the union, and this
painful adjustment involves much
needed structural reforms that provoke
social unrest. If EMU was founded
purely for economic reasons, surely it
would not have been conceived, but
EMU was mostly driven by a desire
on the part of Europeans to avoid
the military conflicts of the past. This
very fundamental founding principle
is currently under serious threat.
Eurozone leaders need to move to the
next level with drastic and difficult
measures to strengthen the existence
of the EMU. Anything other than this
will prove that bond investors are right
to feel apprehensive.
Europe’s crisis so far has not been
accompanied by massive capital flight
from the Eurozone. Exhibit 2 shows
foreigners have been liquidating
European assets, but the scale is not
matched by the larger liquidation
by European investors of foreign
assets that are being repatriated and
sheltered in bunds. However, there
is serious capital flight taking place
within the Eurozone as evident in large
imbalances in TARGET2, the system
that settles cross-border flows among
national central banks in the Eurozone.
Prior to the crisis, trade-deficit outflows
were usually counterbalanced by the
capital inflows of surplus countries.
With the onset of the current crisis,
the weaker nations have incurred
large liabilities (capital flight) and
left the German national bank with
large surplus claims (€650 billion as
of April 2012, equivalent to 25% of
Exhibit 2.
12-Month Sum, Billions
1,000
800
600
400
200
0
-200
No Capital Flight Out of the Eurozone
Eurozone Balance of Payments Portfolio Flows
European Purchases of Foreign Assets
Foreign Purchases of European Assets
-400
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
300
200
100
0
-100
-200
-300
-400
-500
Europeans have been
bringing money home!
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Bloomberg, RBC GAM
Germany’s annual GDP). Eurozone
residents still believe in the cohesion
of the Eurozone as a whole, which
is illustrated by continued positive
net inflows. However, doubts remain
about the ability of the weaker nations
to weather the current crisis. From a
bond-market standpoint, large capital
inflows into the German banking
system will be recycled into bunds.
The rising demand for bunds from the
Eurozone banking system and private
investors is taking place while the
supply of bunds dwindles. The fear of
contagion if Greece exits the Eurozone
is causing extended turmoil in financial
markets and sending bund yields lower
by the day. Markets are scrutinizing
the Greek political campaign leading
up to the June 17 election to assess
the possibility of damage from
contagion in the global financial
system. Investors are also monitoring
the political will of the member states
to hold the Eurozone together in the
face of antagonistic domestic political
agendas.
SAMPLE
In addition to risk aversion, centralbank
intervention has been fueling
the rally in government bonds. All
major central banks have intervened
in the past three months, either by
expanding their balance sheets or
offering generous liquidity. However,
quantitative easing by the Bank of
England has now ended, and the U.S.
Federal Reserve Board’s “Operation
The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 35