Global Economic Concerns Continue September 2011

Global Economic Concerns Continue

Global macro concerns once again dominated comment and speculation during the second quarter of 2011. The biggest of these has been the crisis in Europe over the debt of the peripheral economies, particularly Greece. Added to this we have seen weakening economic data coming out of America in areas such as housing and unemployment, and the further tightening in China implemented to dampen down their inflationary threat.

At the beginning of the quarter the most likely threat to continuing global growth seemed to be inflation, with many observers suggesting portfolios needed to be positioned for this by reducing holdings in fixed interest, particularly sovereign and investment grade debt. The reality of the quarter has been somewhat different with yield on government debt falling as investors sought safe havens in times of global uncertainty. The yield on 10 year US treasuries fell to below 3% in June. Some observers believe this is a temporary respite for the fixed interest markets and that the ten-year bull run in bonds will end when inflation has a greater effect on interest rates. As a consequence the dollar is still being seen positively alongside gold and other stronger sovereign assets.

The threat of inflation remains a longer-term consequence of all the monetary stimulus that central banks have pushed into the system although we may see a fall off in the next few months as fuel price rises and VAT in the UK fall out of the calculation.

Looking forward, most economists use leading indicators to determine the future for economic growth. Many of these indicators have fallen over the last few months, with the key driver for this being the broad-based decline in Purchasing Managers Index surveys (PMIs) in most countries. In the US, the drop in the Institute of Supply Managers Index (ISM) from 60.4 to 53.5 was well below expectations, and subsequent non-farm payroll growth of just fifty four thousand, and the unemployment rate increase to 9.1% was even more disappointing*. In Europe, the German Ifo Index and the European Commission sentiment index have both peaked, although at reasonably high levels. In Japan the PMI stands significantly below 50*, signifying contraction in the second quarter. There is little doubt that economic growth has slowed, especially in the US, however, on an absolute basis, some leading indicators still point to reasonable positive growth rates. Growth on the US front is predicted to be between 1.5% and 3%, even after these revisions, which clearly is not recessionary. The position is similar in many parts of Europe and the central case still suggests an average growth rate in the west of 2-2.5%* which remains positive with the proviso that tail risks are running higher because of political and debt instability.

In many areas of the globe there are still significant and diverse concerns - the common thread among them seems to be the need for strong political leadership. In Washington, leadership is needed to raise the debt ceiling in a timely manner and deal with the long-term fiscal profile of the US. In Tokyo, leadership is required to provide supplemental financing to stimulate the post-earthquake recovery, while in Germany, leadership is needed to confirm support for the Eurozone before another sovereign crisis.

* Source: Goldman Sachs May 2011

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