Fixed interest

January 2012 (covering December 2011)

The eurozone debt crisis was the dominant market story in December, just as it had been for most of 2011. A series of decisions and announcements early in the month by European authorities combined to deliver a substantial package of support to the eurozone’s stricken sovereign debt markets and to the European banking system. The main results of the EU heads of government summit were: an agreement on stricter rules on fiscal discipline (which will be enacted through treaty change and embedded in national law), the commitment of an additional €200bn of funding to the IMF and the decision to bring forward, and strengthen, the European Stability Mechanism (ESM).

While the plans for treaty change lack detail at this point, and so provide little immediate tangible support, they indicate an effort to move to closer fiscal co-ordination over time, something which could underpin confidence in the single currency project.

The ECB has been providing steady support to eurozone sovereign markets over the past several months but has now taken significant new steps to support European banks. Two three-year funding schemes (LTROs) were announced, along with a 50% reduction in reserve requirements for banks participating in these deals. Demand for the first operation was very strong. The ECB also reduced its main policy rate by 25bps to 1%, unwinding the second of the rate rises of earlier in 2011. It remains to be seen whether these actions will provide enough support to the sovereign debt markets of the eurozone to see them through the heavy schedule of refinancing they face in the next few months.

Economic news from Europe underlined the growth fall-off in the second half of 2011. Eurozone industrial production growth has dropped to its lowest level since the region’s recession ended in 2009. Business sentiment indicates that this deceleration is set to continue. In the UK, persistently weak employment growth is depressing consumption. With inflation now decreasing (down from 5.2% to 4.8% between September and November), monetary authorities are considering further quantitative easing after the current programme is completed. Data from the US remain more positive. While personal spending growth is still sluggish, the rebound in business confidence has been sustained and has been backed up in recent data releases by improvements in unemployment (falling to a two year low of 8.6% in November) and consumer confidence.

Core government bonds continued to find market support in December, as they have for several months. The yield on the 10 year Gilt fell 34bps to close the year on 1.98%, Treasury and Bund yields also fell. Reflecting a modestly less risk averse environment, corporate bonds achieved positive total returns, sterling investment grade yields falling 30bps for a return of 1.7%. Aided by their substantially higher yields, total returns for subordinated bank debt were relatively high, sterling Tier 1 debt returning 5.2% for the month.

Where Invesco has expressed views and opinions, these may change.