But despite plenty of investment and central bank activity, we continue to see a shortage of economic and financial market confidence.
All eyes on policy makers
In the US, we continue to foresee gross domestic product growth in the area of 2% for the remainder of this year and next. We would stress that the risks are to the downside, particularly if there is a disorderly breakup of the eurozone and/or Congress fails to reach an agreement to avoid the fiscal cliff at the end of this year. If either of these events were to occur, the US could be pushed back into a recession.
Macro and market dynamics in the industrialised world have become increasingly dependent on the actions of policy makers. We’ve seen government outlays,deficits and debts that are high by post-war standards and expansion in central bank balance sheets that is unprecedented.
Share prices have rallied on the belief that policy makers are going to fix our ailments yet again. Examples include the anticipation of QE3 in the US and efforts by the European Central Bank to “do whatever it takes.” In response, the S&P 500 and other averages are up double-digit percentages since their June low.
This past week, minutes from the August 1 Federal Open Market Committee (FOMC) meeting confirmed it is willing to ease the burdens on the economic data. The minutes did not shed much light on what form of easing might take place, but the tone was that QE3 remains firmly on the table for the September FOMC meeting.
Incoming data will probably determine whether the Fed actually acts or simply extends its forward-looking language. We do not expect Fed Chairman Ben Bernanke to send any strong signal about action in his Jackson Hole speech tomorrow.
The fiscal cliffhanger continues
Clearly, the US fiscal cliff remains a primary source of concern and uncertainty, with no action likely until the lame duck session. The case for Congress acting post-election but before the end of the year rests largely on the need to fix the Alternative Minimum Tax (AMT).
Because the AMT provision expired at the end of 2011, it can only be made retroactive in 2012. Without action, $90bn in additional tax payments will hit an estimated 30 million Americans. This is one impetus that may spark some lame duck action. Other motivating factors include the debt ceiling, which needs to be lifted and, of course, the fact that the economy would suffer if the cliff is experienced.
Overall, policy makers across the globe have become increasingly determined to curtail deflationary risks and encourage a sustained economic recovery. This recently helped alleviate investor anxiety, fuelling the risk-on phase. Euro officials were the latest to step up the reflationary efforts, with ECB President Mario Draghi aggressively pushing forward his proposal for purchasing sovereign debt. German Chancellor Angela Merkel has publicly endorsed the ECB proposal, despite disapproval from the German Bundesbanke.
As for China, the third of the big three, policy makers have continued to ease, but only gradually since they are looking to encourage a soft economic landing rather than trigger a sharp re-acceleration in credit growth.
Equity outlook still optimistic
Equities have moved in a fairly narrow range in recent weeks, giving back some of their gains from earlier in the summer. Escaping this range to the upside will require positive economic news and some clarity around policy maker action.
Conversely, policy maker inaction could stoke deflationary fears and cause stocks to slip. Despite the many uncertainties, we are biased toward the former of these two scenarios and, as such, maintain a somewhat positive equity market outlook.
