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Central Banks Signal Downside Risks to Global Growth Outlook

  09/08/2011 

 

     Despite elevated inflation levels, monetary policy makers from Asia to Europe have signaled today a pause in their rate hike cycles. Their reasoning circled around the prevalent global growth concerns that emanate mainly from the deteriorating European credit market and the lackluster growth outlook for the U.S. and Europe. The European Central Bank in particular lowered its growth outlook for the Eurozone to a range of 0.4%-2.2% for 2012 and the ECB chairman also cited moderating inflation risks. The cautionary tone by the Central Banks reflects the risk aversion created by the piecemeal solutions to the European sovereign debt crisis and the impact to European growth by fiscal austerity measures.

     The banking system in Europe continues to be under duress and inter-banking funding premiums across the Atlantic have been on the rise, along with elevated costs for insuring against corporate bond defaults. As a result of these systemic concerns investors have sought refuge in U.S. Treasuries and German Bunds, thus sending their yields to decade lows (2% and 1.84%), not far from the extremely low levels experienced in Japan. One of the sources of these systemic concerns lies with the tentative sovereign debt situation in Greece. As we can see below, the 10-Year yield for Greek government debt is 19% and the yield on the 2-Year note is 51%, thus increasingly pricing in a sovereign default. It is also noteworthy that Greek GDP for Q2 2011 came in today at -7.3% Y-o-Y change, thus highlighting the severe impact of austerity measures to the Greek economy.

 

  

 

 

 

     In addition, it appears that healthy European banks have been increasing their overnight deposits of excess reserves at the ECB and also at the Federal Reserve via reverse repurchase agreements. The below graph on the right is a key warning signal for global financial stress, now at levels above the 2008 credit crisis, which indicates loss of trust in commercial banks and therefore loss of confidence in the European banking system.

 

  

 

     Furthermore, as the ECB is becoming more dovish on its monetary policy, we see downside risks to the EUR vs. the USD, as there is scope for the ECB to cut rates from 1.5% in the next 6 months if the Eurozone economy slows down materially. In such a scenario, the U.S. dollar index (58% euro weighted) is likely to rise, thus hurting commodities such as oil and therefore energy related equities.

 

     Lastly, as far as U.S. monetary policy is concerned, we remain skeptical that further monetary accommodation can have a real impact on the economy. The real Feds Funds rate is not far from decade lows and the velocity of money has been declining, especially since the 2008 crisis. This implies that money in circulation is not used fast enough for purchases of goods and services in the real economy. Therefore, this is another indication that the U.S economy is not as robust as monetary policy would like it to be.

 

  

 

     In conclusion, the economic landscape continues to be fragile and keeps us on the cautious side from an investment strategy perspective. Our focus remains on income generation from MBS, MLPs and large-cap dividend paying equities, for example in the healthcare, consumer staples and telecom sectors.

 

 

 


 

Christos Charalambous CFA  

Senior Strategist

christos.charalambous@edgewealth.com

 

 

 

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