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Global Markets Weekly - 9th February 2009

• The IMF revised down its growth forecasts, notably for Asia...
  Further downward revisions to the IMF’s growth estimates for 2009 and 2010, this time focused on Asia, confirmed what investors already know: the global downturn in growth is continuing and spreading to previously less affected regions.
• ...but the recent numbers have been better than expected.
  As investors, we are interested less in the absolute outlook for economic and earnings growth than in how it compares with what is already priced into markets. In this regard, the early part of the year has provided some relatively good news. An index of economic surprises shows that the data releases over recent weeks have been surprising progressively less to the downside. Some, such as lead indicators of Chinese growth, have brought absolute upside surprises.
• Nevertheless, we forecast further weakness in the months ahead.
  Our forecast remains for a contraction in developed economies for most of 2009, with any growth the result of government spending. So the economic news is likely to remain bleak – witness January’s 580,000 fall in US payrolls. That said, recent weeks are a reminder that sentiment goes in cycles and investors’ tendency to overreact is as great on the downside as on the upside.
• The ECB hinted that it's considering quantitative easing...
  Central banks remain firmly in easing mode: the Bank of England cut interest rates to 1%. Although the European Central Bank (ECB) left rates on hold at 2%, this belied a more dovish outlook. ECB President Jean-Claude Trichet said borrowing costs had not yet reached their lower limit and the ECB ‘did not exclude’ quantitative easing.
• ...which could lead to a period of euro depreciation.
  Such recognition of the deflationary outlook, and the prospect of quantitative easing measures, produced last year’s dollar and sterling weakness. A move by the ECB to a more explicit deflation-fighting stance could spark a similar period of euro weakness.
• That would alleviate the debt burden of Eastern European countries.
  The euro’s strength is increasing the pressure on currencies in Eastern Europe, where borrowers are especially exposed to euro and Swiss franc loans. This relationship between external financing requirements and currency depreciation, already evident in 2008, now appears to be to be reaching a crescendo, but any sustained euro weakness would ease this pressure.
• The prospect of quantitative easing has been behind gold's recent rise...
  Gold has been a beneficiary of currency concerns. In a world of quantitative easing, it makes sense to look at gold relative to another commodity that represents investors’ real economic ability to buy the precious metal. The ‘yellow/black ratio’ (gold per ounce divided by oil per barrel) is one such measure used by commodity traders. The peak of 30 seen in 1985 stemmed from weak oil demand after the early-1980s recession, OPEC quota busting and the Plaza Accord, which managed a sharp dollar depreciation. Such an extreme set of oil-bearish but gold-bullish circumstances (though unlikely to be repeated) would be consistent with a gold price of around $1,000. Fear-driven markets may overshoot this level but, as investors learnt with the oil price in 2008, it’s sensible to keep both feet grounded in economic reality.
• ...as have worries about economic nationalism and competitive devaluation.
  Another concern driving gold higher is the growth of economic nationalism, seen in campaigns for restrictive labour laws in the UK and the ‘Buy American’ legislation being considered by the US Congress. One aspect of economic nationalism is competitive devaluation – an option all the more attractive as it need not be inflationary when demand growth is exceptionally weak. Gold can therefore be a hedge against the politicisation of exchange rates, rather than inflation.

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