Scenario 2013-2014: The Financial Crisis, Act III…and Epilogue?

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New round of central bank liquidity injections worldwide

  • The U.S. economy can’t do without Fed support
  • The euro area is out of recession, but bank sector and sovereign issues remain
  • The Fed, BoJ, BoE and ECB continue to nurse ailing economies

Continued low interest rates are not enough to dispel emerging risks

  • The momentum driving global trade has been undermined for the foreseeable future
  • China can no longer act as the global engine of growth
  • Foreign exchange rate adjustments appear inevitable

Is inflation, end-point of the financial crisis, around the corner? 

  • New round of liquidity injections, currency crises, geopolitical tension, labor unrest…
  • … Inflation remains the most likely scenario, but the path ahead is unclear

World Growth Monitor

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Going it alone. The global economic picture is unquestionably looking brighter. Unlike previous recoveries, however, this one is fueled above all by consumer spending. The trend is especially noteworthy in Europe now that austerity policies have been scrapped. But it can also be observed in the United States—since the country has steered clear of the fiscal cliff dangers at the start of the year—and Japan, where the Abe administration’s first moves have lifted the spirits of local consumers. Even in China, sustained consumer spending is what has offset the negative impact of an end to export support. So on the whole, the environment is more encouraging. Yet the missing ingredient here is what proved to be one of the key drivers of global growth in the 1990s—world trade. This has two main implications:

  1. Global growth will be weaker than in the past, and will stay that way for some time.
  2. There will be greater risk for economies that are still too dependent on exports, i.e., the emerging economies in general and more specifically those suffering from structural imbalances—Brazil, India, and South Africa—and increasingly burdened by mounting current account deficits.

Global Inflation

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The Gold Selloff as Warning Sign for Impending Deflation

Recent disappointment with a sluggish economy has altered perceptions about the risk of inflation. Since the beginning of March, ten-year inflation expectations in the U.S. bond market have shed 30 basis points, the sharpest decline in the past year. At the same time, plummeting gold prices bear witness to growing doubts about the reflationary policies pursued by central banks. Moreover, current global trends suggest that this sentiment won’t be changing any time soon:

  • With inflation rates well below 2 percent and still receding, most industrialized countries are inching their way toward deflationary territory. High unemployment and low capacity utilization rates exert strong downward pressure on wages and producer prices, a trend accentuated by softer energy prices. 
  • The rising inflation observed in an increasing number of emerging economies is in fact limited to those with little global influence, primarily India, Russia, Brazil, and Argentina. Asia’s exporters of manufactured goods still show low inflation rates that are much closer to those in the advanced countries. 

 All these developments should therefore encourage central banks the world over to go further with monetary easing.

Our 2013–2014 Scenario: A Situation Under Control

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  • Global GDP up 3.1 percent in 2013, 4.1 percent in 2014. With difficult conditions prevailing through the first half of 2013, the world economy will not grow any faster than the 3.2 percent registered in 2012. It will take until 2014 for global growth to exceed 4 percent—a level not seen since 2010. 
  • 50–50. Over the next two years, emerging economies will add $4 trillion to their combined GDP (at constant 2010 prices and exchange rates), contributing four times as much to global output as developed countries. By 2014, global GDP should therefore be evenly distributed between the emerging and developed worlds. 
  • Inflation. All quiet on this front in 2013, but will start to edge up in 2014. Weak growth and receding commodity prices in early 2013 should keep a lid on inflation throughout the year. However, more vigorous recovery in 2014 will push commodity prices up (with oil reaching $130) and accelerate inflation in emerging markets.
  • Sovereigns. Budget deficits should ease slightly in 2013; public debt will continue to swell in 2013 and 2014. Countries that have structurally weakened and whose reform policies have yet to kick in will still be at risk. Italy tops the list, followed by Spain; France is balanced on the razor’s edge; and the future of Japan will depend on how successful the new prime minister’s stimulus program is.
  • The U.S. unemployment rate will diminish to 6.5 percent in the first half of 2014. The Fed’s quantitative easing program will be over. Expectations that interest rates will revert to normal levels will bring the period of low long-term rates in the Western world to an end.
  • 10-year U.S. Treasury Note yields will hit 3.5 percent by end-2014. The rise in U.S. long-term yields will go from gradual in the latter half of 2013 to more pronounced in 2014. Europe will follow suit, with a moderate widening of the T-Bond/Bund spread.
  • The euro will trade at $1.35 in 2013. The Fed’s vastly expanded balance sheet, combined with the elimination of extreme risk in the euro area, will keep the dollar low against the euro in 2013. But the trend will reverse in 2014 when the Fed abandons its unconventional policy tools.