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Broadgate: Weekly Briefing

5 January 2012

Greece – Greek Prime Minister Lucas Papademos has said Greece may default on its debts in March unless unions accept further cuts to salaries. Mr Papademos said more cuts were needed to avoid exiting the eurozone.

European Commission, International Monetary Fund (IMF) and European Central Bank (ECB) inspectors, known as the troika, arrive to assess Greece’s progress in cutting its deficit on 15 January.

They will decide whether to provide further bailout funds to the country.

“Without an agreement with the troika and further funding, Greece in March faces an immediate risk of an uncontrolled default,” Mr Papademos said.

Germany – German unemployment fell to its lowest rate in December since 1991, according to the German Federal Labour Agency. The adjusted jobless rate fell to 6.8percent from 6.9percent in November, the Federal Labour Office said.

This marked a new record low since figures for unified Germany were first published.

The seasonally-adjusted total for the number of people out of work in Germany fell 22,000 to 2.88 million in December.

Leading economists expect Germany’s economic growth to slow in 2012, however, in line with other major eurozone economies, which may put a squeeze on wages and jobs.

Europe – Euro-area services and manufacturing output contracted less than initially estimated in December, led by Germany, the region’s largest economy, where output reached a four-month high.

“The uplift in the eurozone PMI in December does little to dispel fears of the region sliding back into recession,” Chris Williamson, chief economist at Markit, said.

“Despite the upturn, the fourth quarter saw the steepest contraction since the spring of 2009, and forward-looking indicators suggest that a further decline is on the cards for the first quarter of 2012,” he said. “In particular, orders for goods and services continued to collapse, suggesting that output and employment will be cut as we move into the new year.”

U.S. – The U.S. Federal Reserve (Fed) has said it will publish regular interest rate forecasts in an effort to improve transparency at the central bank.

It means the public will be given an indication of how the Fed thinks rates will move for years into the future. Up until now the Fed’s statements have only provided vague statements as to long-term rate movements (the bank’s current guidance, for example, suggests rates will stay low “through mid-2013”).

Instead the bank will now publish detailed forecasts from each member of its 17-member rate setting committee.

“The SEP will include information about participants’ projections of the appropriate level of the target federal funds rate in the fourth quarter of the current year and the next few calendar years, and over the longer run,” said the committee’s minutes.

U.S. – U.S. manufacturing activity hit a six-month high in December, according to a survey from the Institute for Supply Management (ISM).

The ISM’s index, which looks at orders, production and jobs, rose to a higher-than-expected level of 53.9 in December, up from 52.7 in November (any value above 50 indicates expansion in sector).

It was the 29th month in a row that the sector has grown and the latest in a run of positive indicators from the U.S.

“At face value, (the figures are) already consistent with annualised GDP growth of between 2.5percent and 3percent. This sits comfortably with other data suggesting that the economy is gaining traction,” said Paul Dales, Senior U.S. Economist at Capital Economics.

China – China has uncovered CNY531bn (USD84bn) of irregularities in local government debts. The National Audit Office said breaches included “irregular credit guarantees”, “irregular collateral” and “fraudulent and underpayment of registered capital”.

There are growing concerns about the amount of bad loans being held by local governments. Official figures show they held debt of CNY.7tn (USD1.7tn) in 2010.

Local governments have been borrowing money from Chinese banks to fund projects aimed at maintaining economic growth. According to the China Banking Regulatory Commission, local governments took up 80percent of total bank lending in China at the end of 2010.

Commodities – Oil climbed to the highest level in more than seven months this week as manufacturing in the U.S. and Asia expanded in December and concern persisted that further sanctions against Iran may disrupt shipments through the Persian Gulf.

Futures gained 4.2percent after the Institute for Supply Management’s U.S. factory index rose more than expected, adding to increases in China and India.

Meanwhile, gold futures jumped the most in 10 weeks on demand for a haven following a report that Iran produced its first nuclear-fuel rod. Silver surged the most in five months as the dollar’s decline spurred a commodity rally.

Spotlight on: the year ahead for sovereign debt

As Greece announces that it is unlikely to meet its next round of debt obligations, the spotlight once again turns to sovereign debt as the most likely drag on global economic growth in 2012.

Governments of the world’s leading economies have more than USD7.6tn of debt maturing this year, with most likely to face a rise in borrowing costs.

Led by Japan’s USD3tn and the U.S.’s USD2.8tn, the amount coming due for the Group of Seven nations and Brazil, Russia, India and China is up from USD7.4tn at this time last year, according to data compiled by Bloomberg. Ten-year bond yields will be higher by year-end for at least seven of the countries, experts predict.

The IMF cut its forecast for global growth this year to 4percent from a prior estimate of 4.5percent as Europe’s debt crisis spreads, the U.S. struggles to reduce a budget deficit exceeding USD1tn and China’s property market cools.

“The weight of supply may be a concern,” Stuart Thomson, a money manager at Ignis Asset Management Ltd., which oversees USD121bn, said. “Rather than the start of the year being the problem, it’s the middle part of the year that becomes the problem. That’s when we see the slowdown in the global economy having its biggest impact.”

The amount needing to be refinanced rises to more than USD8tn when interest payments are included. Coming after a year in which Standard & Poor’s cut the U.S.’s rating to AA+ from AAA and put 15 European nations on notice for possible downgrades, the competition to find buyers for sovereign debt is heating up.

“It is a big number and obviously because many governments are still in a deficit situation the debt continues to accumulate and that’s one of the biggest problems,” Elwin de Groot, an economist at Rabobank Nederland, part of the world’s biggest agricultural lender, said.

While most of the world’s biggest debtors had little trouble financing their debt load in 2011 (evidenced by the Bank of America Merrill Lynch Global Sovereign Broad Market Plus Index (a gauge of performance of sovereign debt), which gained 6.1percent, the most since 2008), that may well change in 2012.

Italy auctioned EUR7bn of debt on 29th December, less than the EUR8.5bn targeted. With an economy sinking into its fourth recession since 2001, Prime Minister Mario Monti’s government must refinance about USD428bn of securities coming due this year, the third-most, with another USD70bn in interest payments.

Borrowing costs (i.e. the amount that will need to be paid back to investors) for G-7 nations will rise as much as 39percent from 2011, based on forecasts of 10-year government bond yields by economists and strategists. China’s 10-year yields may remain little changed, while India’s are projected to fall to 8.02percent from 8.36percent.

After Italy, France has the most amount of debt coming due, at USD367bn, followed by Germany at USD285bn. Canada has USD221bn, while Brazil has USD169bn, the U.K. has USD165bn, China has USD121bn and India USD57bn. Russia has the least maturing, at USD13bn.

The likelihood of debt payments being made, or the various countries being able to raise more capital from future issues, remains to be seen. As we saw in 2011, there are various means by which struggling countries can stride the next hurdle (central bank intervention, ‘haircuts’ on debt repayments, reluctantly committing to yet higher interest payments on future issues). However 2012 finishes, the sovereign debt issue promises to play a major role in shaping the fortunes of investors on a global scale.

One view that the majority of commentators are agreed on is that 2012 will most definitely be volatile. It is this volatility that seasoned investors use to their advantage, when coupled with a strategic approach to dollar-cost averaging, utilising price fluctuations to regularly purchase units in funds that the market deems undervalued.

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Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.