On growth, recent data suggest that downside risks have diminished considerably, led by China. The chances of a double dip in the US have reduced by about half from the previous 25%. The Fed’s QE also reduces downside risks.
Overall, growth risks are balanced. The upside risk is firms eventually putting cash balances to work in investment and hiring. The downside risk is no improvement in labour markets or consumer incomes and spending.
Vulnerability remains to financial shocks, though the less severe reaction to stress in the eurozone peripherals suggests a reduced sensitivity.
Data may be uneven due to slow final demand growth and inventory and trade swings. The market’s assessment of growth could be fickle.
Europe’s periphery remains a problem and opinions may swing due to data, political developments in the periphery and German comments driven by domestic politics. Adverse shocks are more likely than good ones, which would be EUR negative. Bad news about banks cannot be ruled out either.
We are confident about subdued core inflation in the eurozone, US and Japan. China’s inflation could continue to surprise on the upside but price controls should reduce risks on this front. The main upside risks we worry about are food and oil, in that order. Headline inflation remains subject to difficult-to-predict swings.
On policy, the Fed could surprise on QE – but in our view more likely by doing more rather than less than has already been announced. The skew of risks on ECB policy is probably towards more tightness. Wage developments as well as growth in Germany will be important to ECB policy. China could be more aggressive on tightening than we think if inflation is stronger, giving downside risks to risk assets.
Tensions remain severe between the US and China and more clashes seem likely on the currency, risking currency and trade wars.
We expect markets to be volatile, but central banks will try to curb the vol. They might even succeed, in which case risk assets would do better and the USD might be weaker.
The market’s reaction to QE2 remains uncertain over the longer term. On the one hand, the Fed is reducing Treasury supply to the market, which is bond positive, while promising to raise inflation – which is bond negative.
The bond forecasts look balanced near term, but upside risks from commodity risks give an upside skew later.
QE2 is a downside risk for the USD across the board.
Friday, November 19, 2010
Tug Of War - Latest Global Outlook By BNP Paribas
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