Evercore Pan Asset

The new Head of the IMF turned spin doctor this week. She wrote of the need to promote growth as well as to reduce deficits. She warned against short term measures to curb deficits which could cut growth, whilst supporting longer term measures to get the deficits down.

Her agonised remarks sum up the current western dilemma. Markets have little confidence in a range of countries that have borrowed too much. They want the high borrowers to get their deficits down. Markets also understand that growth brings extra tax revenues which helps get on top of debts, and understand that if western growth stalls many more things go wrong.

Euroland has been wrestling with this problem again this week. The July fix did not last into August, with the markets forcing down the values of Italian and Spanish government bonds in protest at the lack of a credible policy to deal with debts in the zone. The Franco-German summit decided on stronger surveillance of deficits and budgets from the Euro centre, but the Germans are  not yet prepared to accept common borrowing in  Euros where the prudent countries like Germany help the less prudent like Greece or Portugal borrow on a collective credit status.

The European Central Bank announced it had bought in €22 billion of sovereign bonds in the first few days of the new policy. This has brought Spanish and Italian 10 year rates down by 1% or 100 basis points. Bulls say it shows the authorities can get back in charge. Bears point out that it is going to prove very expensive to keep up that rate of purchasing. Buying up bonds to inflate the price and push down yields is a temporary fix, not a solution to the underlying problem of too much debt.

The UK has been sitting on the sidelines. Its own government  bond market has actually benefitted from the dislocation elsewhere, with buyers attracted to a country with an independent currency and a clear deficit reduction plan. The problem for the UK, like other deficit reducing countries, is it needs growth to deliver the figures. The strategy relies heavily on extra tax revenues from growth over the next four years to hit the lower deficit plans. The government aims to be raising more than £170 billion extra in 2014-15 compared to 2009-10.

This year the Budget forecasts the UK government will borrow an extra £122billion, compared to £146 billion last year. In the first three months of the new financial year from April the government borrowed £39.2 billion, just £0.3 billion less than the same period the previous year. It implies there is more work to be done to get the deficit under control as planned.

We continue to advise against Euroland investment. Germany is not yet prepared to stand behind all the debts and deficits in the zone, whilst there are still troubles in getting credible debt and deficit containment plans working in each stressed country. China looks to us to be the cheapest major share market, and there are a few signs this week that the authorities are now worrying about growth instead of wishing to take every measure possible to slow the economy to get inflation down.