The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.
Since last fall, global equity markets have benefitted across the board from various positive signs that the much-anticipated economic recovery was finally taking hold — at least in the U.S. Double-digit returns in the last six months reflect those positive views, but as we enter the second quarter, the global macroeconomic outlook remains fragile. Potential headwinds in the coming months are again focused on the European sovereign debt crisis, growth-related surging global oil prices, China's accelerating economic slowdown, and uncertainty relating to the post- U.S. presidential election fiscal policy adjustment — all adding to the recent market anxiety.
Euro Zone Status
In the Euro zone, the ongoing EMU sovereign debt crisis continues to percolate, with associated financial market strains expected to increase again. The recently implemented and somewhat severe fiscal tightening measures in the peripheral member countries is now being blamed for related recessions via anemic revenues, making fiscal sustainability appear remote. Greece's financial footing remains on an unsustainable path as further debt restructuring is now expected. Market watchers estimate a 50 percent chance of an eventual Greek exit from the euro as early as next year. Portugal and Ireland both will probably require a second financial bailout. Spain continues to suffer fiscal slippage via its recent upward revision to its official budget deficit now expected to exceed 6 percent of GDP. The markets expect further downgrades of EMU periphery sovereign ratings. But for now, the calming effect of the ECB's huge three-year Long Term Refinancing Operations (LTRO) is expected to be short-lived given the ECB's stated intention to implement no further LTROs.
The recent rise in crude oil prices is also expected to impede growth this year, as price-sensitive global oil consumers, whose incomes tend to fall in tandem with higher oil costs, are likely to adjust personal consumption faster and further than the oil producers can adjust their production levels. The previous occasions when oil prices hit $125 - $130/barrel range in mid-2008 and 2011, were followed by marked downturns in global trade flows and corresponding GDP growth forecasts.
China's expected economic slowdown appears to be gaining unexpected momentum. Last year's policy tightening measures to slow the country's housing market and corresponding credit growth could be the cause of actually overshooting its intended goal. Last week, the National Bureau of Statistics reported Q1 GDP results at a three-year low of 8.1 percent versus the forecasted 8.9 percent, further elevating concerns of China's deepening growth slide. Additional monetary loosening is now expected via continued Reserve Requirement Ratio cuts by the PBoC, which should rebound growth later in the year. However, the momentum of the near-term slowdown remains a global concern.
Meanwhile in the U.S…
Major uncertainties about U.S. fiscal policy for 2013 and beyond could be an issue as well. The current prospect of broad-based tax hikes and related spending cuts may slow the recovery next year, although forestalling that action appears unlikely before the U.S. presidential election in November. As in 2010 and 2011, the short-term economic rally may suffer if the market anticipates that the central bank stimulus is going to end, which adds to current market worries. Despite the slow recovery, private debt loads remain high in the U.S. and in Europe, creating the ongoing bias of elevated saving levels, which could reassert another downturn.
Given these various headwinds, the major central banks will probably continue to maintain their loose policy stance on rates, with an eye on loosening further if downside risks escalate again. In the U.S., policymakers currently don't seem prepared to commit additional QE, but the possibility that growth rates don't meet official projections later in the year keeps alive the Fed's option of continuing its Mortgage Backed Securities (MBS) purchase program.
In Euroland, it's expected that the ECB will cut rates below the current one percent level sometime in the next two quarters. If EMU economic pressures increase, then the ECB is also expected to implement one or more longer-term LTRO stimulus programs to again calm jittery markets.
In the UK, market expectations of further QE in the short-term seems unlikely, but with growth and inflation estimates likely to undershoot official MPC forecasts later this year, the Bank of England may be forced to act.
Despite the aforementioned economic currents, the FX markets are expected to follow more normalized fundamentals where currency strength is related to growth outperformance and expectations of higher yields versus weakness related to elevated risk-on/risk-off trading patterns that have been the norm since the global credit crisis of 2007 - 2008.
Against most of the majors, the USD should strengthen later in the year if the improving U.S. economy outperforms most of Europe and Asia. This would benefit equities and suggests improved bond yields as improving economic data seen as the central drivers.
The EUR continues to be buffeted both by news on the current fiscal/balance of payments crisis within the EMU and by relative monetary policy updates. Near-term currency forecasts point to little change from current levels as neither the Fed or ECB are expected to announce significant/new monetary initiatives. Longer-term (second half of 2012), the EUR is expected to weaken via the ECB's eventual easing initiatives, possibly down to the 1.25 level.
Looking ahead, history would suggest that the current global recovery will be strong and robust, even though it's been so long in coming. Because there's often no clear line that marks the "recovery" stage after a deep financial crisis, the uneven recovery experienced the last couple of years may lead to more unchartered waters ahead.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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