General

Richard Skelt, Fidelity portfolio manager- October 2011

“Last night’s agreement lessens the risk of systemic shock once the agreed mechanisms are in place, and markets are responding positively to this. Looking out beyond the immediate relief rally, a number of headwinds remain. There is a continued policy emphasis on austerity at the expense of growth within Europe which will create a drag for the southern European countries particularly, and the measures imposed on the banking system are also likely to be negative for credit and growth. The longer term path for equities will be determined by the economic cycle globally and less so by political activity in Europe.”

Eugene Philalithis, Fidelity portfolio manager- October 2011

“I think the package makes significant progress in terms of the various bank funding and liquidity channels, although some details still need to be resolved. The proposals to leverage the European Financial Stability Fund and expand its scope are also positive for sovereign funding liquidity. The agreement on the bank recapitalisations is also a significant step forward, the intention of governments being to prevent banks meaningfully shrinking their balance sheets through selling assets or cutting off the supply of credit to the economy.

Anecdotally, I had a meeting with a bank loans manager this morning who mentioned that banks will most likely dispose of non-core assets, such as infrastructure loans and possibly commercial real estate, while keeping the corporate book largely untouched as it is performing well and pays more than their cost of funding. But the supply of new credit to the economy could still be hampered, which is likely to be negative. The statement made it clear that private sector Involvement in Greece is a special case, and it will remain to be seen whether the markets accept this and contagion is prevented. But even with a 50% haircut in Greek government debt, the debt:GDP ratio is expected to fall to 120% by 2020, hardly providing an immediate solution to the solvency problem.

Concerns still remain with the lack of detail on implementation for some of these schemes, but there is another meeting in early November where more detail may be provided. Finally, the commitment to enshrine fiscal prudence within national legislation means more austerity is on the horizon for Europe, which leaves the European Central Bank as the only solution for growth. Without looser monetary policy growth prospects in Europe do not look bright. I think we will see a relief rally in equities and bank debt, as well as peripheral bonds (excluding Greece), and a stronger euro potentially, but at some point the economic fundamentals may overwhelm the initial optimism, so I will take a cautious approach to adding risk.”

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