Economic outlook
Although fiscal drag increased massively in the United
States, the US economy remained quite resilient. This resilience stands in
stark contrast with the continuing recession in the European Union but possibly
also with slower growth in Asia, and in particular in China. We expect growth
to remain moderate in the United States as the fiscal drag is likely to persist
through 2013. If the recovery in the United States is to appear sustainable,
the Federal Reserve might first decrease the rate of liquidity injection, and
subsequently - but only very gradually - reduce liquidity. As a result we do
not expect interest rates to significantly increase globally. It is to be seen
of course, how more vulnerable economies will face higher financing costs, in
particular European periphery economies, but plausibly also some emerging
markets.
Stocks
Stocks have come under pressures as uncertainties about the
slowdown of the US economy, alternated with concerns about QE tapering by the
Federal Reserve. As we will move through 2013, QE tapering concerns will become
the main concern, as the US housing sector will continue to improve. The change
in monetary policy is likely to prevent very strong rises in equity markets.
Yet, equity markets should recover earlier than bond markets from the change in
monetary policy direction. As yields stabilise, we would expect equity prices
to move up again sometime after the summer, albeit at a more moderate rate as
we had during the first part of 2013.
Commodities
Prospective monetary tightening in the United States, as
well as a secular globaIly deflationary trend, do not bode well for commodity
prices. Gold will remain under pressure as emerging markets suffer less
inflation, and their current account surpluses continue to shrink. Smaller
current accounts mean that these countries, which over the last years have been
important buyers of gold, will reduce their demand for this precious metal. If
yields continue to rise, this could act as a drag on gold prices as it loses
relative appeal compared with bonds. In a global low growth environment,
industrial metals are unlikely to pick up meaningfully. This is even more
relevant because the biggest consumer of industrial metals, China, will
continue to grow at rates that are significantly lower than the double-digit
rates we were used to in the previous years.
Given this current economic slow-down, oil prices are also
expected to remain subdued. However, as long as uncertainties in the Middle
East persist, oil prices are unlikely to go significantly below 100 US dollar
the barrel. If uncertainties are able to translate into an effective rise of
tensions, for instance the nuclear energy standoff between Iran and the US, we
would not exclude a sharp rise in the oil price.
Bonds
The steady pace of economic growth in the US has, as we had
expected, ensured a continuation of the current upward trend in bond yields.
This has been further exacerbated by new economic projections by the Fed which
makes tapering of the QE program more likely. German yields have also
increased, albeit at a lower pace due to continued weakness in the periphery of
Europe. The massive increase in Japanese yields reflects, for now, that markets
are taking the BoJ's inflation targets seriously.
We expect global yields to rise a little further but to
stabilise sometime towards the end of 2013. Although recent movements in yield
suggest an end in the 30 year bull market, more evidence is required for this
to be conclusive.
Currencies
Whilst US yields have thus far risen more than yields in
Europe, the euro has remained remarkably resilient. In fact, whilst many
currencies - in particular commodity currencies and the yen - have suffered
against the US dollar, the EUR/USD exchange rate has not changed significantly.
As real reforms in Europe are likely to deliver results only very gradually,
and as significant fiscal stimulus appears politically unfeasible, we would
expect the European Central Bank at some point to deliver more stimulus through
some sort of unconventional liquidity injection. In other words, we expect the
European Central Bank to catch up with other major central banks. As that
happens, and as the Federal Reserve will start tapering QE, we expect the euro
to weaken versus the US dollar. Likewise the yen will also weaken as the Bank
of Japan is likely to further step up stimulus through 2013. We also believe
that commodity currencies, such as the Australian dollar, will continue to
suffer against the US dollar because of less demand for raw materials from
China.
Major Risks and
Opportunities
The "sequester" might still derail the US recovery
in 2013. This would clearly force the Federal Reserve to protract rather than
unwind Quantitative Easing. Paradoxically, unless the slowdown in growth is
violent, such a situation could lengthen, rather than undo, the current upswing
in equities. Again, under the scenario of a violent slowdown safe-haven flows
would strengthen the US dollar, the yen and the Swiss franc versus the Euro and
Sterling. If the slowdown is more moderate, currency implications would be less
straightforward as the continuing expansionary stance of US monetary policy
might stall the upward trend of the greenback.
We consider fiscal consolidation in the Euro-zone as a
special risk factor. In fact, social hardship in the periphery might well undo
continuing political support for austerity. To overcome this type of risk, more
progress on the banking union and more relaxation on austerity would be
welcome. This is, however, unlikely to happen before the German elections in
September. As such, recurrent spikes in spreads and downward pressures on the
Euro and periphery equity markets are not to be excluded. China may face
political economy issues as it moves away from an export-driven growth model to
a more domestically driven growth model. Internal political problems might also
aggravate external territorial tensions with its neighbours. Further more the
People`s Bank of China have taken a hard line regarding credit expansion due to
its rapid rise in the first quarter. If this stance by the PBoC continues, the
implicaions for the overvalued real estate market and GDP growth in general
could be dire.
The major risk countries right now are still Egypt, Syria
and Iran. Recently also Turkey seems to question its political destiny. Further
political destabilisation in the region might lead to a simultaneous increase
in USD and in oil prices. Historically the solution of political problems in
the Middle East, or the prospect thereof, have often led to tailwinds for equity
markets.
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