Global View: A Complicated Outlook

A new year has begun but the world economy still faces the major challenges of 2011. With no politically feasible quick fix, the European debt crisis is here to stay. If anything, the challenges for the European indebted economies seem even greater, with the entire region entering recession in Q4 last year.

However, not everything has turned for the worse. The US economy is not heading into a recession as many feared in the autumn. On the contrary, growth is now reaccelerating and the hope is that the emerging growth acceleration will  spill over to emerging markets – in particular China – and eventually to Europe.

Global central banks have recognised the need to act further to stem the global growth slowdown. Central bankers have indicated that there is still ammunition left to fight the crisis and they are ready to use it. The ECB has acted by cutting rates and ramping nonstandard measures up significantly to prevent a European credit crunch.

Last year has left the markets braced for high uncertainty and an elevated risk of global recession. While we share the view that the global outlook remains unusually complicated, we also recognise that times of  great uncertainty usually also represent times of great opportunity. We have identified four themes that we believe will dominate the rate markets in the coming quarter.

• No global recession: The markets are still pricing a relatively high probability of global recession. Given the recent signs of  a  pickup in US growth and signs of stabilisation in China and Germany, we believe the market is still overstating the risk of a global recession.

• Global monetary policy easing: Global monetary policy is set to be eased further during H1 12. Where there is room, in our view, lending rates will be cut further and otherwise non-standard policy measures will be ramped up to support the functioning of the financial system.

• Euro crisis to stay: The euro crisis will stay with us but the hope is that it will be less dominant for the markets if global growth picks up. However, increasingly tight credit conditions, deleveraging, public austerity measures and uncertainty imply that the eurozone will underperform global growth for an extended period.

• High implied volatility: The market comes out of an extremely volatile period and implied volatility is still high. Improving global growth and successful implementation of non-standard policy measures should result in a decline in
realised volatility. There are already signs of this in several markets.