It would appear that we are still generally in a world of relatively small moves, but these small moves recently have been more to the upside than the downside, and equity markets over the past few weeks have made progress. Progress was particularly evident last week, with most markets up by somewhere between 3% and 6%. It leaves most indices in positive territory for the year to date, offsetting the falls witnessed in January, while in some markets, notably the UK, share prices have now reached their highest levels since just before the demise of Lehmans in autumn 2008.
Two factors have been relatively important in the past week. The first is the rising potential of US economic data, where this week, despite witnessing a decline in February numbers, the fall in US employment was less than expected. This is particularly interesting given the poor weather conditions and there is now a real chance that when we get data from March we will see a positive number for US employment.
Turning to Europe, we also saw slightly better news on Greece. Overall bond yields were little changed last week, particularly in the major developed economies, but we saw a slight rally in Greek bonds. This was as a result of the announcement of more-identifiable fiscal tightening, and also a Greek bond issue that was taken up relatively aggressively. It left Greek spreads still relatively high, but off the peaks registered a few weeks ago.
Other risk assets generally made gains last week as well: the oil price has risen further, along with industrial metals. Currencies were somewhat more subdued. The overall theme has been one of weakness in European currencies, partly, as we shall see, because the growth background is just less robust than elsewhere, but in addition we have seen political concerns over Greek debt and the possibility of a hung parliament in the UK.
Taking a closer look at what has been going on in the global economy, it is important to emphasise that we have not been looking at a one-speed global economy and it is helpful to divide the global economy into three broad groups. The first group, emerging markets, most particularly in Asia, began recovering relatively earlier in the year, regaining losses and output, and growing very quickly. As an example, the Korean economy during the course of 2008 rose by 6%, highlighting that emerging markets are clearly much stronger than the developed markets at this stage.
However, if we look at the more-developed markets, there is also some important differentiation between them. For example, the US economy was contracting in the first half of 2009 but clearly rebounded in the second half, growing by around 4% at an annual rate, and the rate that we are going to see in the first quarter of this year is not going to be a great deal slower than that.
The trouble comes when we turn to Europe and Japan, although the latter, it must be said, did finish the year strongly. While the quarterly annualised data showed that the economy grew by almost 5% in the fourth quarter of 2009, the quarters before were pretty erratic, and Japan had, by far, the harshest recession of all the developed economies, and is still suffering from the largest loss in output.
The real problem area, though, really is Europe. We know that the UK economy did expand in the fourth quarter, but only by the same amount that it contracted in the third quarter, so the UK had in effect a flat second half of the year, which compares and contrasts badly with the US, which was up 4%. In the same period Europe did deliver a small amount of growth, but not a great deal.
This picture leaves us looking at a three-tier global economy. In terms of whether this is likely to continue, there is good reason to believe that emerging markets will grow faster than the developed economies - they do not have the same banking problems, savings can fall rather than maybe having to rise further, and also there is little need in emerging markets for the clear tightenings in fiscal policy, which must come at some stage.
These issues are less relevant in emerging markets simply because budget deficits are at much more sustainable levels and, when we look at the growth divide between the US and Europe, it is quite likely that the US will continue to grow more rapidly, benefiting from a more-stimulative policy stance than Europe overall.
The implications here are important in terms of prospective interest rate trends. It is difficult to see the European Central Bank raising European rates any time soon, and the same is true for the Bank of England and UK rates. It is perfectly feasible, given the sluggish growth start and the sluggish growth outlook for UK and the Euro area, that, in fact, we see short rates on hold for much, if not all of this year.
That may also be the outturn in the US, but on balance markets are going to perceive the possibility that the US may raise interest rates at some stage this year as being greater than the probability in Europe, and probably Japan.
This leaves a very different environment from what we have witnessed - where we have already seen some tightening in Chinese interest rates - and we are likely to see, as a general theme in emerging markets, interest rates rising from emergency low levels because they no longer need to be there.
It potentially offers an important theme over the coming months, namely that emerging market currencies continuing to appreciate against the currencies for the developed economies, and in this context it is interesting that there is increasing speculation that the Chinese will allow some appreciation in the renminbi against the US dollar, reinstating the policy of gradual appreciation that was in place from the middle of 2005 to the middle of 2008.
If we do see general strength in emerging market currencies, this is an interesting source of potential return for emerging market investors over and above any gains in the equity indices.
We may also see some divergence between expected US monetary policy and expected European policy, which gives us some slight bias towards the dollar’s trend continuing to be upwards, irrespective really of what happens in European peripheral bond markets.
Meanwhile, we have had no major shifts in views on the key asset classes recently. We continue to believe that we are in a grinding bull market for equities, in which we will see further gains but also, during the course of this year, more sell-offs of the sort that were experienced in January.
We continue to believe that bond yields are range bound, but anticipate that the next major move in bond yields, whenever it occurs, is much more likely to be up than down. This reaffirms our bias, at this stage, towards risk assets.
