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Canadian investors in global bonds should keep an eye on recent events in Europe, but they shouldn’t lose sleep over the U.K. budget or the fall of Portugal’s government, according to fixed income experts.

However bond pundits admit that tight fiscal policies are a negative for currencies.

“The bad news is that historically when you have tight budget policies and fiscal contractions like they’re experiencing in the U.K., the exposure here would be the Sterling weakness versus the Canadian dollar,” says Francis Scotland, director of global macro research, Brandywine Global Investment Management, in Montreal.

There was, however, nothing unexpected in the U.K. budget for Serge Pepin, head of investments, BMO Investments Inc. “What [U.K. Chancellor, George] Osborne came out with was not surprising at all,” he says. “The U.K. is suffering from some economic uncertainties [and] what the budget indicated was really more of an austerity to get the fiscal house in order.”

Pepin points out the 10-year bond yield edged from 3.55% to 3.58%, suggesting market was prepared for what the budget contained. As for investors, he says, there’s no escape from the four-letter word—risk—but asserts there are ways to minimize it.

“I think that government bonds can play a very important role in your portfolio [so long as investors stay] informed and try avoiding the pitfalls.”

Scotland says he supports the British fiscal measures as detailed in the budget tabled on March 23. “The Brits are doing the right thing; they have an unsustainable deficit position and they’re biting the bullet.”

From a point of view of currency, the biggest source of alpha in terms of Canadian investors’ exposure to British bonds, the risks are small and short-lived, he says. “[The risks] strike me as fairly short-term and medium-term, given how deeply depressed their currency already is relative to history; there’s not a whole lot of medium-term risk.”

There are some positive signs coming in from continental Europe, where all efforts are being made to contain the debt contagion to two or three smaller economies. For now, though, all eyes are on Portugal, where financing risks spiked after parliament rejected new austerity measures and the prime minister resigned, creating something of a political paralysis.

“If Portugal ends up going into the same intensive care unit as Ireland and Greece, then Portuguese bond [yields] are going to go a lot higher,” says Scotland. The dilemma for investors in these three countries lies in how to handicap a situation that’s largely been priced in.

Pepin, though still invested in the eurozone, wouldn’t touch the Irish, Greek and Portuguese bonds with a bargepole. “We’re just not seeing any value at this point; [there’s] so much uncertainty and so much volatility. We can find better opportunities somewhere else.”  

And while Pepin’s own economic compass points to emerging markets, he cautions investors not to write off Europe as a whole, as there are ways around its existing problems.

The leading economies of the eurozone are doing just that. There’s a growing sense among economists that the E.U. is trying to ring-fence the financial system of Europe to maintain stability at all costs. This is expected to increasingly marginalize Portugal, Ireland and Greece from being at the centre of the financial issues dominating the European agenda as the stronger economies devise a plan around restructuring.

Originally published on Advisor.ca
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