Aviva Investors has improved its six month outlook on the global economy following September’s aggressive policy response from the world’s top three central banks (Federal Reserve, European Central Bank, Bank of Japan).
Aviva Investors’ investment strategy team, which provides asset allocation advice to clients, has forecast a 65% probability of “Better Days” as one of its three potential economic scenarios*. The improved outlook recognises the boost to growth and risk assets expected from the abundant liquidity that September’s quantitative easing announcements have created. However, the new “Growth Stall” scenario (20%) highlights the risk that despite aggressive central bank action, the economic backdrop remains weak and could still disappoint.
The two new scenarios replace the previous “Hard Times” (40%) and “Great Expectations” (30%) scenarios, in which global growth was set to remain below trend. The third scenario “Financial Crisis”, has remained the same, but now carries half the probability (15%), further supporting a more positive outlook on the world economy.
Better Days (65%) |
Growth Stall (20%) |
Financial Crisis (15%) |
• Coordinated monetary policy reduces tail risks and provides modest stimulatory effect to global growth. Risk assets remain supported.
• US growth remains subdued – circa 2%. Improvements in housing market support domestic demand which helps offset weakness in the manufacturing sector. Fiscal cliff is avoided.
• Eurozone stays in recession, but Greece remains in and a banking crisis is avoided. ECB buys more time.
• Asia manages a ‘soft landing’, easing policy to offset the current slowdown.
• Liquidity conditions remain buoyant boosting confidence and risk assets. Equities make modest progress towards pre-crisis highs; bonds yields edge up slightly and spreads remain flattish, but USD weakens.
• Liquidity boost could cause another leg up in commodity prices.
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• On-going growth deceleration, so far mostly ignored by financial markets, becomes major cause of concern.
• In the US, fiscal cliff uncertainty holds back corporate investment and hiring plans. High food and oil prices hinder consumer spending.
• Chinese policymakers fail to deliver sufficient easing, resulting in a weaker than expected growth outcome, Asia continues to disappoint.
• Hit to global trade and activity from the EU crisis becomes more pronounced.
• Risk assets correct from overbought levels as economic reality catches up. Equities sell-off and bonds yields fall but in a contained manner as central banks remain responsive. Credit spreads rise.
• USD and JPY remain supported, AUD and other risk-on currencies suffer.
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• The ECB may have provided a backstop to the European Crisis but many questions remain unanswered. A host of factors could still reignite fears and lead investors to test the ECB’s resolve:
• Greece’s inability to meet its fiscal targets may yet result in a forced exit from the Eurozone, triggering fears of a bank run across Southern Europe.
• The state of the Spanish banking system may require more money than ‘core’ countries are willing to provide.
• Social unrest persists across Europe.
• Inadequate policy response and negative financial market feedback loops hit US growth and result in broad economic weakness across the World.
• Risk-off dominates. Equities fall as markets de-rate aggressively. Credit spreads widen, especially high-yield. USD, gold and Treasuries benefit from flight-to-safety.
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Shamik Dhar, head of investment strategy at Aviva Investors, said:
“The central bank policies enacted in September removed a significant element of the near-term tail risk previously clouding financial markets. In response, September and early October saw risk assets such as equities approach their pre-crisis peaks, sovereign and corporate bond spreads narrow, and implied volatility fall to record lows.
“While our constellation of scenarios suggests a continued supportive environment for risk assets, there are reasons to remain cautious. More recently, poor earnings have caused a fall in equities and the fiscal cliff is a particular concern even after the presidential election. Our ‘Growth Stall’ scenario captures that.
“Furthermore, while the ECB successfully altered the rules of the game in September, economic struggle remains the norm in Europe. Peripheral bond markets have rallied strongly but as ever, the timelines of EU decision-makers and financial markets remains at odds with each other. Our ‘Better Days’ scenario assumes the ECB has bought European politicians enough time to come up with a credible package of debt burden-sharing agreements that will ultimately put the monetary union on a sound footing. There is a chance that they won’t be able to deliver however, which is why we retain the ‘Financial Crisis’ scenario, albeit on a much lower probability.”
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