• Recovery. The world-wide recession has run its course, the global economy has already returned to growth, and most forward-looking economic indicators point clearly north. And the GDP numbers for China being released next week will probably provide initial proof that the pace of growth around the globe even accelerated at the turn of the year.

  • US. We are also making a slight upward adjustment to our US growth path. In the final quarter of 2009, real GDP probably grew at an annual rate of 4½%, the strongest gain since the beginning of 2006. We do, however, still have lingering doubts about the sustainability of the recovery and we expect a dip for summer 2010 (pages 3-5).

  • Germany. In Europe, the dip appears to have already materialized, when relying on Germany’s Federal Statistical Office which has hinted that after two quarters of growth German GDP probably stagnated again in 4Q 2009. We, however, consider this more a statistical fluke that could already be corrected at the beginning of this year (pages 8-10).

  • EMU. The fact is, however, that the recovery in the euro zone is not selfsustaining or durable either, but will tend to experience ups and downs. The most severe recession since the Great Depression will, therefore, likely be followed by only a meager upswing in 2010. The dichotomy between good sentiment and weaker hard data will probably be with us several more months (pages 6-7).

  • Further topics:

    – Weekly Comment: Structural imbalances (page 2).

    – France: The real test is coming with the recovery (page 11).

    – ECB: Treading cautiously (page 13).

    – Data outlook: Purchasing managers guardedly optimistic (page 14).

    – Market outlook: EUR-USD hovering around 1.45 (page 19).


Structural imbalances

The new year has started with more of a whimper than a bang. German GDP data and the latest readings on US retail sales and jobless claims were disappointingly weak, a sober reminder that the recovery ahead is indeed fragile, and is likely to be moderate. The growth outlook seems indeed likely to remain as lackluster as we have described it in our 2010 outlook publications – and especially for the eurozone we remain comfortable with our below-consensus projection. Low growth could perhaps facilitate the ECB’s task: as long as growth appears so weak, implying a prolonged period of high unemployment, spare capacity, and therefore no serious inflation pressures, the ECB can take a cautious approach to its exit strategy. This was indeed confirmed at the January 14 meeting, where ECB President Trichet provided no fresh indications on the next steps, but he confirmed that throughout the first quarter of this year liquidity will remain abundant, keeping short-term rates at very low levels.

Weak growth, however, will make it harder for governments to meet the daunting fiscal challenges, and 2010 has opened with attention still focused on Greece’s predicament. The Greek government is hard at work to come up with fiscal adjustment measures strong enough to reassure investors, and is of course facing an uphill struggle in light of the widespread doubts on the reliability of its statistics. The IMF announced it is sending a mission to provide technical assistance, and while the IMF does have a lot of technical expertise that could be very useful in the current circumstances, some people will no doubt wonder whether this is just a reconnaissance mission paving the way for a more traditional financial assistance mission. And while Greece is certainly the most troubled case at the moment, there are other countries that face a challenging fiscal situation, beginning with Portugal and Spain. In all these cases, lack of growth will make it that much harder to put the fiscal accounts in order.

The year has also opened amidst concerns that we might be heading towards a replay of some of the past errors. The Bank for International Settlements has openly expressed concerns that banks might become dependent on the current very steep yield curves, going back into the habit of making money via carry trades. At face value, the implicit criticism is baffling: central bankers have gone out of their way to steepen yield curves exactly in order to allow banks to turn profitable again and recapitalize themselves—surely they should be way more disappointed if banks had been too shy to take advantage of the opportunity. Of course, banks will need to adjust to a different environment as yield curves steepen, but the parallel process of recapitalization and strengthening of supervision and risk controls should exactly be aimed at ensuring that they will be able to handle the adjustment. We should also keep in mind that the financial sector has been handling periodic flattening and steepening movements in yield curves for quite a long time.

Of more concern should instead be the risk of a recurrence of the infamous global macro imbalances. There is a very broad agreement that global macro imbalances played an important role in the process that led to the subprime crisis. Interpretations of course differ: Fed Chairman Bernanke earlier this month mounted a vigorous defense of the Fed’s monetary policy of the last ten years. First, he argued that US monetary policy was not too loose during the previous easing cycle: feeding into a Taylor rule the inflation projections and estimates of output gap available at the time, he argued, the path of interest rates “recommended” by the rule is not that different from the one that was actually implemented. Second, he rejected the charge that loose Fed policy was to blame for the US housing bubble. He argued that for that charge to be valid, one would expect to see that countries with looser monetary policy should have experienced greater increases in house prices, whereas a crosscountry analysis shows virtually no such correlation. The correlation of housing prices is stronger with capital inflows, which Bernanke sees as consistent with his “savings glut” hypothesis: in this view, the original sin lies in the structurally high savings rate in China and other emerging markets, which resulted in large capital flows to the US, pushing down long-term interest rates and creating the conditions for yieldhunting. Bernanke’s conclusion was that the best way to deal with incipient bubbles is not tight monetary policy, but targeted measures including regulation. The argument is sound, but one could of course counter that as long as there is excessive liquidity, better regulation in one area will simply shift the bubble somewhere else.

The main concern, however, is that Bernanke is indeed right in pointing out that the global imbalances were caused by fundamental, structural forces. And exactly because of this it seems very likely that these same imbalances might recur. Serious structural reforms are needed for China to be able to lower its private savings rate, and until then the country will continue to run large current account surpluses. On the other side, the sharp contraction in the US current account deficit seems to have been driven mostly by the deep recession, and as the recession eases, the gap might well open up again. As the imbalances widen again, large capital flows will follow. And while a lot of attention and thought has been given to the restructuring of the global financial system, little homework seems to have been done so far on how to make the same system more resilient to a likely resurgence of global imbalances. It would be better to start now, in a hurry.