The outlook for the euro is dire, according to the Frankfurt-based Georg Schuh, head of fixed income, Europe, for Deutsche Asset Management, and investors should react accordingly.The showdown in the Eurozone is approaching fast, Schuh said.
“Either politicians achieve a big bang soon, by transferring union of the Eurozone, or capital markets will require even higher risk premia,” he said.
“We are at a critical juncture in the global economic cycle; after the soft patch in Q2 we are facing negative GDP revisions for 2012 at this moment. Any further downgrades would lead to a recessionary environment.”
The Eurozone situation was complex, Schuh said, but a showdown was near because markets were forcing the question of whether there would be a common Eurozone bond.
“I think that is unlikely; even if there was political will, the constitutional hurdles would be extremely high. The execution in practice would make it difficult. There would need to be a change to the treaty; there are 17 constitution countries that would need a referendum – the whole thing could take years.”
Furthering the complexity in the zone is the emergence of the European Financial Stability Facility (EFSF), which is a new bond issuer.
It has a AAA rating, but Schuh believed this would be difficult to sustain because it depended on the rating of France and Germany.
“Rating downgrades force investors to react, and politicians underestimate how much investors rely on ratings,” he says.
“If France loses its AAA [rating] then it affects the EFSF rating.”
Further, Schuh said the specific Eurozone debt crisis could affect the larger landscape.
“The acceleration of the Euro sovereign crisis is dominating the investment outlook, replacing the theme ‘the power of no return on cash’. The breakup of the Eurozone is not just a tail-risk scenario,” he said. “So the time of overweighting risk assets, and equities, is over.”
Schuh said investors should move away from traditional market cap benchmarks, which have inherently biased allocations to higher risk countries.
“From an investor’s point of view it is time to act,” he said. “And that means moving away from pan European indices.”
Schuh said the economic conditions called for more bottom-up country analysis, and the integration of the outlook of credit analysts – which had specific knowledge of defaults – as well as emerging markets specialists.