Investor sentiment about the economic outlook is improving... Investor sentiment has picked up significantly since the March lows for capital markets. With increasing signs that the first quarter of the year is likely to have been the worst part of the current global recession , investors have switched from fearing a downward spiral to anticipating an economic recovery.
...but optimism will be tested by a slow and torturous recovery... We continue to forecast an economic recovery starting in the US by the end of the year and spreading to the rest of the developed world in 2010. However, we expect the recovery to be patchy and not without risks, so we remain relatively cautious in the short term. Investors may have their patience tested over the summer as they wait for the recovery to begin.
…with interest rates held at very low levels until the recovery is firmly established. Interest rates have been cut to emergency levels – as close to zero as is appropriate for the functioning of the local banking systems. While we appear to be at the low point for this interest rate cycle, the need for additional quantitative easing (QE) underlines the extraordinary nature of the economic crisis . As a result, we believe that interest rates are likely to remain at low levels for an extended period, not rising until late 2010 or even 2011.
We favour defensive currencies such as the dollar in the near term. Longer term, concerns about QE and fiscal policy may weigh on developed-market currencies. In this environment, we emphasise the attractions of the US dollar and other safe havens, such as the yen. By contrast we would avoid currencies linked to commodity prices, such as the Australian dollar, or dependent on a rapid return to global growth, such as the euro. While emerging market currencies may prosper, we would not expect significant appreciation from currencies with managed exchange rates until governments are confident that this will not derail growth. In the longer term, relative outperformance from emerging market currencies is set to be driven by concerns that QE and fiscal policy will debase the currencies of developed economies.
