19 Dec 2011
Comment from Tomas Jelf, Chief Economist, Prologue Capital
One of our key theses over the past year has been the on-going deleveraging process in the developed world which we expect to weigh on activity and make economies vulnerable to shocks. As we come to the tail end of the year, the mother of all shocks may be materialising; the deepening crisis in Europe. This threatens not just Europe but the entire global economy.
A catastrophic outcome can still be avoided but a European recession is now a given which has the potential to materially affect the global economy. This is unusual as Europe typically lags rather than leads the cycle.
The change in the sequencing will prove a challenge to investors who have been conditioned to look tothe United States for cyclical direction.Meanwhile, the United States’ economy has done better than we expected during the second half of this year. Unfortunately, we don’t think the relative strength will persist.
Equally important is the shift in inflation. Next year a disinflationary trend is likely which may bring back deflationary fears. In short, the outlook for the economies we follow looks dire with further market stress likely. Policy support is forthcoming but its potency is questionable.
Concluding thoughts
Developed markets generally follow the expected path following a financial crisis; the recovery is subdued and economies continue to depend on policy support. The crisis in the Eurozone has added a significant layer of downside risk that will remain in place for some time. The stress will likely intensify early next year when the recession is becoming more entrenched and funding needs become burdensome again.
Meanwhile the current trend shift in inflation will be more noticeable next year which could result in renewed deflationary fears. This is an environment which requires very loose monetary policy for a protracted period. Thus, our bias will remain towards long duration strategies even at these low yield levels. We will also be very sensitive to signs of renewed financial stress which could lead to dramatic flight to quality trades. Fiscal concerns will continue to be at the forefront of market participants minds. Those fears primarily pertain to Europe for now but the risk that they start to affect other bond markets have increased.
The trading environment is likely to remain challenging, not least since various policy initiatives particularly in Europe will lead to dramatic, albeit temporary market reversals. Being nimble will be crucial and our trading decisions will remain more tactical than strategic.
One of our key theses over the past year has been the on-going deleveraging process in the developed world which we expect to weigh on activity and make economies vulnerable to shocks. As we come to the tail end of the year, the mother of all shocks may be materialising; the deepening crisis in Europe. This threatens not just Europe but the entire global economy.
A catastrophic outcome can still be avoided but a European recession is now a given which has the potential to materially affect the global economy. This is unusual as Europe typically lags rather than leads the cycle.
The change in the sequencing will prove a challenge to investors who have been conditioned to look tothe United States for cyclical direction.Meanwhile, the United States’ economy has done better than we expected during the second half of this year. Unfortunately, we don’t think the relative strength will persist.
Equally important is the shift in inflation. Next year a disinflationary trend is likely which may bring back deflationary fears. In short, the outlook for the economies we follow looks dire with further market stress likely. Policy support is forthcoming but its potency is questionable.
Concluding thoughts
Developed markets generally follow the expected path following a financial crisis; the recovery is subdued and economies continue to depend on policy support. The crisis in the Eurozone has added a significant layer of downside risk that will remain in place for some time. The stress will likely intensify early next year when the recession is becoming more entrenched and funding needs become burdensome again.
Meanwhile the current trend shift in inflation will be more noticeable next year which could result in renewed deflationary fears. This is an environment which requires very loose monetary policy for a protracted period. Thus, our bias will remain towards long duration strategies even at these low yield levels. We will also be very sensitive to signs of renewed financial stress which could lead to dramatic flight to quality trades. Fiscal concerns will continue to be at the forefront of market participants minds. Those fears primarily pertain to Europe for now but the risk that they start to affect other bond markets have increased.
The trading environment is likely to remain challenging, not least since various policy initiatives particularly in Europe will lead to dramatic, albeit temporary market reversals. Being nimble will be crucial and our trading decisions will remain more tactical than strategic.
