Recent market developments
Although economic data are no longer surprising as strongly on the upside as previously, they have generally pointed towards continued recovery in the world economy and accelerating growth rates towards the end of the year, as witnessed by the strong reporting season. Equity prices have almost rebounded to their 2009 highs, following a negative correction a couple of weeks ago. The recovery in credit markets has lost momentum, but this is not a matter of concern, given the significant improvement over the past 6-9 months.
Long bond yields have generally remained unchanged over the past month. However, curves have steepened due to a decline in short rates, reflecting less aggressive expectations of rate hikes. Overall, yields are still kept in check by very dovish central banks, strong demand for government bonds from Asia and commercial banks, and bond purchases by western central banks. Further, the steep yield curves continue to make speculating in higher yields expensive.
Macro outlook
The US economy has put recession behind it and most leading indicators are now consistent with the ongoing recovery. In Q4 09 and Q1 10 we expect to see relatively strong growth on the back of stimulus-driven spending, a realignment of production to demand and the release of a pent-up demand.
The big issue is whether the initial boost to the economy from these drivers will be sufficient to initiate a self-sustained recovery. There is a minor risk of the recovery fizzling out, but we believe that the demand from households and businesses will be sufficiently strong by early next year to head off a set-back. In this context, it is important that the labour market begins to deliver jobs by year-end, that the US personal savings rate does not start surging and that oil prices remain stable.
Euroland has also pulled out of recession. A combination of a major production backlog and the turnaround in the global industrial cycle is helping exports while also boosting investment. Also, solid growth in the US and Asian economies will benefit the eurozone in the coming quarters.
Inflation is not an issue in either the eurozone or the US. Core inflation is set to move lower in the coming quarters on the back of low capacity utilisation and slowing wage growth. Headline inflation should increase as commodity prices move upwards, but should remain modest in both the US and Euroland.
