March 2011
Anticipations Monthly
Philippe Waechter Chief Economist at Natixis Asset Management
Global growth is healthy. Surveys of business sentiment in the two first months of the year suggest a clear pickup in activity for the first quarter. The global activity indicator is at its highest since May 2004. This should translate into an acceleration of global output and international trade. The trend is evident across all the world’s regions. It is also becoming more self-sustained as expansionary budget policies are wound down in most countries, though not the US.
That said, business surveys reported to date have yet to factor in the lateFebruary jump in oil prices. Crude prices have surged to over USD 115/barrel as geopolitical tensions intensified in North Africa and the Middle East. A continued price rise could impair global growth. Economic agents would be forced to trade off rising energy costs against other spending. Saudi Arabia’s intervention should make good the production cuts linked to the revolt in Libya. Short term, it has succeeded in stabilising the oil price.
o Our macroeconomic analysis In emerging economies, activity remains robust. Asia continues to grow strongly and Russia and Brazil are striking a more positive tone. After a sharp recovery in 2009-2010 followed by a dip in the second half of 2010, many emerging market countries are now settling into a more sustainable medium-term growth trend. The economic cycle has, for most, returned to normal and central banks are getting ready to step in. They will be all the more tempted to act given the rising price of commodities, particularly food, which is driving a significant surge in inflation. In developed countries, activity is also picking up but is still not back to pre-crisis levels. This is why we have seen little improvement in the employment situation so far. In the US, GDP rose at an annualized 2.8% in the fourth quarter, compared to 2.6% in the previous quarter, boosted by healthy household consumption. The pace of growth probably
picked further up in the first quarter. New orders remain strong and inventories are running down. Industrial companies should therefore be scaling up output to meet the rising demand. Household consumption should also continue to benefit from the tax breaks voted by the government in December 2010 and the Fed’s continuation of its highly accommodative monetary policy. Nevertheless, if the steep climb in gasoline prices (+10.4% between February 21 and March 7) persists, it could eat into household spending. In the euro zone, while growth in the final quarter 2010 was slightly disappointing, surveys suggest the beginnings of a more even trend. New orders are up and trade is accelerating, driving a rise in output and employment. Activity is improving in all countries except Greece. The ECB will probably start hiking rates in April to dampen inflationary pressures and this threatens to undermine the ongoing recovery in the euro zone just as government budgets are starting to get more restrictive.
o Our market analysis n Money market In Europe, the ECB left policy rates unchanged at its March 3 meeting but surprised the markets when it suggested policy tightening was now imminent. By omitting the ritual mention that rate levels remained appropriate, describing monetary policy as very accommodating and using the phrase “strong vigilance” about upside risks to price stability, Jean-Claude Trichet was clearly softening up the markets for a likely rate increase at its April 7 meeting. The refinancing rate will probably rise 25bp to 1.25%. The ECB also said it would keep non-standard measures in force for another three months. It will therefore continue to inject unlimited liquidity until July 2011. In the US, the Fed has maintained rates near zero and plans to keep them there for an extended period. Economic recovery continues but is too weak to significantly help the labor market. Also, the US central bank is debating whether to halt or continue its bond purchases at the end of June. Lastly, in the UK, the Bank of England is in a tricky position. Recovery looks fragile and inflation is rising sharply. At the MPC meeting on February 9 and 10, three members voted to raise policy rates. That will probably happen between now and June.
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Anticipations Monthly / March 2011
n Bond markets Since the start of the year, 10-year yields have risen slightly on both sides of the Atlantic as the economic outlook has improved. The US 10-year Treasury was yielding 3.5% at March 10, 2011, up from 3.3% at the turn of the year. In Germany 10-year yields were 3.3% on March 10 compared to 2.9% at year-end 2010. Euro zone 2-year yields have come under severe pressure however as markets start to anticipate ECB policy tightening. German 2-year rates were 1.6% on March 10, 2011, against 0.9% on December 31, 2010. Markets had begun the year in a happier frame of mind about the euro zone’s peripheral countries but tensions in Portugal, Ireland and Greece re-emerged with fresh force in early February. Investors continue to question whether these countries can balance their budgets and honor their commitments.
n Equity markets Having risen on the back of an improving economic outlook and a good results season, equity markets have now wiped out part of the gains made since the start of
the year. Rising uncertainty in the oil markets, triggered by geopolitical tensions in North Africa and Libya, has driven short-term changes in expectations. If unrest were to envelop the rest of the Middle East and imperil oil production, the price of crude would quickly spiral to a point where it threatened an economic shock.
n Currency markets The euro rallied strongly against the dollar, largely on sentiment that the ECB will be raising rates earlier than previously thought while the Fed said it was sticking with its strategy. The euro bought USD 1.38 on March 10, 2011, compared to USD 1.30 on January 12.
n Commodities Commodity prices have risen strongly, led by rising prices for oil (since the start of the year) and food (since summer-2010, due to the heat wave that shriveled cereal harvests in Russia). Pressure on cereals, particularly wheat and maize, has been easing somewhat since mid-March.
SITUATION IN JAPAN o Macroeconomic environment
o Investment strategy
nP ast experience of earthquake-type catastrophes suggests that when they happen in a developed country there is no lasting impact on the economy.
n Generally, we became more cautious about risky asset classes early in the month, partly due to the rise in commodity prices and its impact on growth. The situation in Japan persuades us to maintain a neutral to underweight position on equities.
n For the country concerned, while the overall impact is limited, there is generally a regional rebalancing. The zone where the catastrophe hit suffers lasting effects. n The impact of such shocks on the global economy has in the past been modest and short-lived. n We doubt the disaster in Japan will knock the global trend off track. Knock-on effects will be limited and local unless a worsening of the nuclear situation prompts a fresh bout of uncertainty. New concerns on this front would ramp up risk aversion and this could then significantly affect the trend of the economy as a whole. Conclusion: in a global environment of expansion, our overall scenario is unchanged. However, we are watching developments carefully, alert to greater risk aversion which would lead us to revise this scenario. We will be keeping a close eye on the news but also on trends in indicators where breakouts could signal a shift in tone (e.g. VIX volatility index sustained above 30, Brent breaking USD 130).
nW ithin this asset class we are neutral on Japanese stocks. We also think Japanese bond yields should drift slightly downward. nC urrency : we have no position on the yen. Rapid repatriation of capital could stoke volatility. n We remain “positive“ on commodities. • Upside pressures on oil prices. Demand will grow in Japan as thermal power plants are brought onstream. • Food prices should be bolstered by possible risks of radioactive contamination. n We are considering reweighting Asia (ex Japan) in the equities market. Output, particularly of electronic goods, could rise in these countries as they pick up lost Japanese production.
Written on 21/03/2011
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Anticipations Monthly / March 2011
o Our current allocation preferences Risk categories
Risk subcategories
Tactical allocation*
Commentary
Feb. 11(1)
Mar. 11(2)
FIXED INCOME
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e remain “neutral” on the bond market. We expect little change in long-term interest rates as W a result of greater global uncertainty.
EQUITIES
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e switch to “neutral”, on macroeconomic uncertainties, a not-too-distant peak in activity and W fewer upside surprises in store from corporate results.
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We remain “neutral”. The rise in activity is not enough to allow a clear improvement in the jobs market. The Fed will therefore keep rates low for an extended period.
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e remain “neutral”. The ECB’s pro-active stance on inflationary expectations argues for W long-term stability in interest rates.
e remain “neutral”. Deflationary pressures and a fragile recovery will lead the Bank of Japan W to keep rates near zero.
Corporate inv. grade
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e remain “positive”. Potential spread-tightening is still on the cards, particularly and more W sharply for financials and their subordinated debt issues.
United States
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We switch to “neutral” on uncertainty as to the future trend in oil prices and its consequences for activity.
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e remain “positive”. Rising geopolitical tensions in the Middle East and North Africa should W continue to affect the price of oil.
United States Euro-zone FIXED INCOME
UK Emerging markets Japan
EURO ISSUERS
EQUITIES
Euro-zone UK Japan Dollar
CURRENCIES (AGAINST THE EURO)
Yen Sterling
COMMODITIES
Oil Gold
We remain “neutral”. We switch to “neutral”.
e have switched to “neutral“ on geopolitical risks and the prospects for a pick-up in activity W after the first quarter, which we see as limited. We switch to “neutral”. e switch to “neutral” on the fragility of the recovery. The strong yen is also hampering W exporters. “Neutral”: The euro/dollar exchange rate should stabilize. “Neutral”: The yen should stabilize against the euro. “Neutral”: Sterling should stabilize.
We remain “positive”. In a highly uncertain environment, gold should retain its safe-haven appeal.
Scale from -- to ++
*weighting gap vs. strategic allocation of an investor
(1) Investment committee as of 26/01/2011. (2) Investment committee as of 24/02/2011.
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Written on 21/03/2011
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