| LONDON, April 26
LONDON, April 26 Hints the euro zone may shift
away from front-loaded fiscal austerity have been treated kindly
by financial markets this week as bond investors seem
comfortable with at least a measured tilt in the policy mix.
With business sentiment in many euro zone countries, notably
Germany, deteriorating again this month and jobless numbers
continuing to rise, policymakers have signalled a need to ease
back on draconian deadlines for deep budget cuts.
Backed by the International Monetary Fund, European
Commission chief Jose Manuel Barroso said popular support for
the current trajectory of austerity had "reached its limits".
Barroso's economic affairs commissioner Olli Rehn stressed a
longer-term approach to debt control, saying: "We have the room
to make fiscal policy with a more medium-term view."
Even German finance minister Wolfgang Schaeuble acknowledged
there was room for flexibility in deficit targets, although
Berlin's staunch advocates of fiscal retrenchment still insisted
both cuts and structural reforms must continue.
The discovery of flaws in what had become benchmark academic
research used to support tight control of sovereign debt has
also helped shift the debate about whether governments tackling
the crisis should focus more on austerity or
Far from running scared at the prospect of a loosening of
austerity, as many deficit hawks have feared, major investors -
encouraged by hopes of a small cut in European Central Bank
interest rates next week - piled into Italian and Spanish bonds.
Italy's 10-year borrowing costs fell to their lowest since
the euro crisis erupted in 2010, while two-year yields fell to
their least since the euro's 1999 inception, despite its
recession, massive debts and a continued political impasse.
And despite another slew of poor economic data and
underwhelming results from the European corporate earnings
season, euro zone stocks clocked up five straight days
of gains through Thursday.
Given the responses late last month to Reuters monthly fund
manager survey, that should not have been too surprising. Asked
whether an easing of euro zone and UK fiscal austerity would be
positive for both the region's bonds and equities, 17 out of 22
global asset managers who replied said 'yes'.
TWEAKS ACCEPTABLE TO BONDHOLDERS
The euro zone policy shift, at least initially, is likely to
centre on pushing back on deadlines for getting annual budget
deficits under 3 percent of gross domestic product.
While this appears uncontroversial for creditors, some major
bond holders reckon it may be the limit of manoeuvrability.
David Zahn, Head of European government bonds at
California-based fund manager Franklin Templeton, which has more
than $800 billion in assets under management, says a "tweaking"
of fiscal plans - rather than spending sprees - would be
Zahn, who said he remained bullish on Italian government
bonds while avoiding German Bunds and holding no British gilts,
told Reuters this week it was important the overall fiscal
programme in the euro zone remained broadly intact.
"It really depends on the amount of what they do - if it's
just about pushing it out a year or two but they are still
basically on track, I think that's OK," he said.
"If they can come up with a pro-growth strategy that would
be great - but I can't see that without lots of spending and
they can't afford the spending. The market in general would not
see that favourably."
Zahn said the euro was a "political animal" by construct,
and that policy consensus took time to form. An investor must
therefore take a long view and focus on relative value in the
meantime. "It is difficult to see growth coming back to Europe
in the near future but that doesn't necessarily mean you don't
hold the bonds," he added.
That echoed recent comments from Scott Thiel, head of
European and global bonds at the world's biggest asset manager,
BlackRock - which has almost $4 trillion in assets under
management. Thiel told Reuters the euro zone faced a "multi-year
corrective process" and that it was way too early to look at
growth today and judge long-term debt sustainability.
But some investors remain uneasy about the euro zone's debt
burden and lack of economic growth and argue that the ECB's
bond-buying pledge relieves governments of the need to act.
Keith Wade, chief strategist at UK-based Schroders, which
manages more than 200 billion pounds in assets, said the ECB's
powerful backstop for bonds and its provision of bank liquidity
had positive and negative effects.
"Clearly such action has created a much-needed breathing
space for the euro, but by removing the danger of crisis it has
taken the pressure off governments to take action."
And many investors remain sceptical the whole euro-area
debt-and-growth circle can be ultimately squared without
bondholders taking a hit somewhere.
"I'm very fearful Europe won't be able to rely on austerity
to solve the debt crisis," said Chris Iggo, Chief Investment
Officer, Fixed Income at AXA Investment Managers, which has more
than 500 billion euros of assets under management.
And "there isn't growth or inflation, so some kind of
restructuring or debt relief will be necessary."