Recent market developments

Economic data has been mixed over the past month but generally points to a sustained recovery in the world economy. Asia continues to look very strong with Chinese data in particular surprising on the upside while November data in Euroland has been on the soft side. In the US, recent indicators continue to point to a stabilisation in the labour market and strong growth momentum going into 2010 although a temporary setback in the housing market is likely in the coming months. Equities have touched new highs and credit markets have resumed the recovery with credit spreads tightening further.

Euroland short yields have taken back the increase seen up to year-end and are back to levels just above the December low. On the other side of the Atlantic, a continued dovish Fed and a couple of downside surprises in economic data have sent short end yields down in the first weeks of the year but levels are still above the extraordinary lows seen in early December. The run-up in 10-year yields has not been reversed to the same extent in either Euroland or the US and yield curves have steepened further. This continues to make speculating in higher yields expensive.

Macro outlook

In the US leading indicators are suggesting that growth momentum was strong going into 2010. We expect to see growth well above trend in Q4 09 and Q1 10 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 to head off any setback. Positive employment growth within the current quarter, the US personal savings rate not starting to surge, and oil prices remaining stable, are key issues for our outlook. In this respect, the recent upward revision to the US savings rate and signs of stabilisation in the labour market are encouraging.

In Euroland a combination of a major production backlog and the turnaround in the global industrial cycle is helping exports while also boosting investment. Furthermore, stabilisation in the labour market, low interest rates and tax reductions will lift private consumption. 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. Indeed there is a risk that core inflation in the US could touch zero this year. Headline inflation should increase as commodity prices have rebounded from the lows last year, but should remain modest in both the US and Euroland.