NATIXIS ASSET MANAGEMENT - NATIXIS ASSET MANAGEMENT - NATIXIS ASSET MANAGEMENT - NATIXIS ASSET MANAGEMENT
JANUARY 2010
MARKET FLASH
2010 forecast
by the Investment Management Department at Natixis Asset Management
Summary n Review of 2009 2009, a turbulent year Lessons from the crisis
page 2 page 3
by Dominique Sabassier, Chief Investment Officer at Natixis AM
n 2010 forecast The difficulties of developed countries Relationship between developed and emerging countries Towards an improvement in 2010 Central bank policies
page 4 page 4 page 4 page 5
by Philippe Waechter, Chief Economist at Natixis AM
n Allocation 2010: new era or relapse? A two-stage investment strategy Asset allocation Factors to monitor
page 6 page 7 page 8
by Franck Nicolas, Head of Global Asset Allocation & ALM at Natixis AM
n Appendix
page 10
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MARKET FLASH / JANUARY 2010
Review of 2009
equity markets, cyclical and financial sectors performed well. A new phase thus opened on the financial markets, and there was a change in the nature of risk aversion. Only structured finance seems to have taken a long-lasting hit. At no stage did Natixis Asset Management factor a long systemic crisis, or a “Japanization” of the global economy into its base scenario, given the quick, massive and highly proactive intervention of governments and central banks. Natixis Asset Management did, in fact, anticipate an improvement in the economic data from March 2009. However, it would be a mistake to consider what happened to be a “classic” crisis. In our view, the extent of the crisis, the measures taken and its media profile will have longlasting consequences for global growth. FINANCIAL MARKET PERFORMANCE IN 2009 Total return stock market indices (%) CAC 40 DJ EuroStoxx 50 S&P 500 MSCI Japan MSCI World (developed markets) MSCI emerging markets
27.6 25.7 26.5 9.3 26.5 62.8
Total return bond market indices Eonia Euro MTS global Corporate Investment Grade (I Boxx)
By Dominique Sabassier, Chief Investment Officer at Natixis Asset Management
0.73 4.51 13.1
Commodities Global index (S&P GSCI ) incl. energy metals food
n 2009, a turbulent year 2009 was a year that began against a backdrop of turbulence, with undiluted pessimism and aversion to risk. This situation was triggered by the collapse of Lehman Brothers in September 2009, and worsened in the first few months of the year. A number of latent factors – and sources of new imbalances – were revealed, thereby accentuating the crisis. The extraordinary measures adopted domestically and then internationally took some time to reassure investors. However, these measures began to have an impact from spring 2009. Following the G20 meeting in April, the tone of announcements changed, becoming more reassuring. The cuts in short-term interest rates (which reached very low levels) and governments taking over from banks as guarantors of last resort led to a sharp reduction in risk aversion as soon as the first signs of improvement appeared in the economy. This proactive, but virtuous approach produced a surge in financial asset prices. On the fixed income markets, corporate and high-yield spreads narrowed, while on the
50.3 62.4 91.2 14.7
n Lessons from the crisis • The dominant weight of the emerging countries The crisis has increased the economic weight of emerging countries, especially China. These countries were less affected by the crisis than the industrialized world. This reflects the measures taken by economic agents, the proactiveness of the economic strategies adopted, but also the more limited disruption of their financial and banking systems. Many emerging countries rapidly returned to achieving strong growth rates, compensating for the activity lost to the crisis. Since the start of the noughties, the weight of emerging countries has increased substantially, driven by China and the strengthening of reciprocal economic and financial links. Since then, their autonomy has grown, particularly in the
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2010
financial sphere, enabling them to avoid being dragged into recession by the industrialized countries. The expansion of the G8 to the G20 represents a change in status, reflecting this economic weight and a new political legitimacy. They now have a role to play in the global equilibrium. Their greater financial and technological autonomy offers them choices that can be made without the consent of the industrialized countries. This has had a major effect on the balance of power. In this situation, the industrialized countries would prefer to continue to wield significant influence.
forecast by Philippe Waechter, Chief Economist at Natixis Asset Management
• Debt and the role of governments This unprecedented crisis has placed the public sector centre stage given its capacity to share global risks. Globalization and the reduction in economic constraints have gradually reduced the role of governments and politics. The “elites” have turned more towards economics, finance and banking, attracted by the remuneration levels. Through its interventions at the heart of the financial system and because of the huge sums involved, the crisis has reminded us of the role and importance of the public sector. Governments and central banks have replaced the banks and the markets, becoming the guarantors of the global financial system. The transfer of private debt to the public sector will have a cost that is still difficult to estimate, but what is certain is that its impact will last for many years. From another viewpoint, these commitments may generate fragility and increase volatility. Recent events involving Dubai and Greece provide examples of the sensitivity of markets and investors to the risks associated with the accumulation of debt. These episodes are likely to have considerable knock-on effects. Moreover, will the markets hold up for long if new, similar concerns arise, or if major countries are under threat of downgrades? For example, the AAA rating of a country like the UK is increasingly under scrutiny. During this crisis, the eye-watering public deficits have led to a massive additional increase in government debt. This situation will have to be managed, and the risk of default reduced, with the aim of limiting the devastating effect that this could have on the entire financial system. We believe that the main governments are aware if this situation and of the key role they will have to play in avoiding a further crisis, especially as they no longer have the “means” to deal with a new shock to the economy. The most effective measures for rebalancing the public finances and stabilizing the debt over time involve cutting spending. However, we cannot rule out tax increases, particularly on corporate earnings, for which Natixis Asset Management forecasts a 25% rise in 2010. In this context, increases in company taxes could be tempting, as took place in the US in the 1930s under the New Deal. But these measures may lead to greater regulation to limit risks and return the situation to what it was before.
In 2009, the global economy was in a something of a strange and original situation. Many emerging countries have already absorbed the sharp shock that affected the entire world at the end of 2008. The pace of activity in these countries has now equaled or exceeded the level reached before the crisis. This is the case of China, as well as South Korea and Brazil. Developed countries are still a long way off achieving this. For these countries, a recovery took place in spring 2009. However, activity levels at the end of the third quarter were between 3% and 8% below the highest point of the first half of 2008. For the United States and Europe, this state of affairs has led to a significant drop in employment. To shore up their margins, firms have shed workers to match levels of activity, pushing up an already very high unemployment rate even further. The pick-up in activity will change the outlook and lead to new jobs being created in the first half of 2010, although the severity of the decline and the large numbers of job losses will mean that it will be some time before the unemployment rate falls to any great extent. This ongoing situation will engender considerable uncertainty for households. Given that asset prices (particularly for real estate) are still very low, such an environment is likely to bring about an increase in the savings rate.
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n The difficulties of developed countries
France - growth in salaried employees (%) 3
In developed countries, firms are adjusting to the new environment, particularly as regards employment. They are finding room for maneuver and scope to satisfy demand where it arises.
2 1 .5 1
GDP growth - base 100 in 2005
0 .5
120
0
Brazil S Korea
-0 .5
Australia
115
Taiwan
-1
France
-1 .5
USA
110
Reference base: quarter preceding a 1958 change in the employment trend 1974 1980-83 1983-85 1992 2003 2008-2009
2 .5
Euro-zone
-2
Germany
1
2
3
4
5
6
7
8
9
10
11 12
13 14
15
16
UK
105
not so far been a similar recovery in the United States or in Europe. The situation of SMEs has improved far less than that of other firms - a fragility (along with potentially significant losses) reflected in the numbers of SMEs that have closed. Within this mixed picture there is a factor of uncertainty.
Japan Italy 100
95 2004
2005
2006
2007
2008
2009
Households are opting for prudence and tightening their belts in light of the sluggish labor market. The pick-up in activity that has occurred since spring 2009 owes much to the massive support injected by central banks and governments. The virtuous dynamic between firms and households has yet to be restored. The withdrawal of accommodative economic policies will therefore be complex to implement as these have been fuelling the demand that has benefited firms. This situation will continue in 2010 but could change if the industrialized countries find a way of tapping into emerging countries’ growth. Germany has already managed this.
n Towards an improvement in 2010
n Relationship between developed and emerging countries
• In Europe, the situation varies between countries. A
Activity will improve in 2010, but at a moderate pace that is way below what would be expected at the end of a recession. The combination of three crises - in finance, banking and the economy - has had a profound effect on behavior. All these shocks have had a long-term impact preventing a spontaneous return to the previous trend.
• In the United States, the implementation of a new
stimulus package that could be focused on employment in SMEs will provide reassurance on the strength and sustainability of the recovery. number of countries have a growth model that is no longer operating as it did before the crisis. Spain, Ireland, Greece and Portugal will have to identify new sources of growth to revitalize their economies, replacing the old model that is no longer effective. This will hinder rapid improvement in growth prospects for Europe as a whole. In addition, bond yield volatility (particularly in Greece and Ireland) represents a source of uncertainty that will penalize the entire continent.
Interaction between developed and emerging countries will be a key factor in 2010. Emerging countries have been able to return to high activity levels despite the recession that continues to affect developed countries. This situation translates into greater autonomy and the development of commercial and financial links between emerging countries. Given their domestic difficulties following the crisis, the industrialized countries will be keen to harness the growth of emerging countries in a more direct way. This will be all the more pressing as there has
The fragile nature of the economies of the industrialized countries is reflected in an absence of pressure on production capacity and the labor market. As a result, the acceleration seen at the beginning of the year due to an unfavorable comparison of energy prices will not continue. The inflation rate is likely to move in tandem with oil prices.
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• As for the emerging countries, the situation will be more
Unemployment rate in the Euro-zone
complex because the economic cycle is already advanced and generating constraints, as indicated by the Bank of Australia, which raised its key interest rates three times in the fall of 2009 in order to adjust these to a level appropriate to the economic cycle. We cannot rule out other movements in 2010 in Brazil, South Korea or Argentina. The particular nature of the current cycle would then emerge immediately, since the emerging countries would adopt more aggressive strategies, more rapidly than the industrialized countries. This shift in the balance of power also reflects a changing world.
20 18
Euro zone Germany Belgium Spain Finland Portugal France Ireland Italy Netherlands Austria
16 14 12 10 8 6 4 2 0 2003
2004
2005
2006
2007
2008
2009
If oil prices stabilize, even at around USD 70-80 per barrel, the average inflation rate will remain very low over the year.
Brazil - foreign trade Relative weighting of trade with various regions (%) 60.00
n Central bank policies
Europe
China + India + Hong Kong
USA
50.00
• For the central banks of the industrialized countries,
the global situation suggests that key interest rates should remain very low. The monetary authorities regularly reiterate this message so as to stabilize investors’ expectations of the markets. The central bankers demonstrate their willingness to make commitments in order to avoid harming the recovery. This recurring theme is perceived as rational and credible by financial market operators as inflation expectations are very low. Key interest rates should therefore remain relatively stable throughout 2010.
40.00 30.00 20.00 10.00 0.00 1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
ACTIVITY FORECASTS AND PRICE GROWTH GDP growth (%) USA
Euro-zone
Germany
France
UK
Japan
Brazil
S Korea
China
2009
-2.5
-3.9
-4.9
-2.4
-4.8
-5.3
-0.5
0.2
8.7
2010
2.9
1.1
1.4
1.2
1.2
1.1
5
5.5
9.5
Inflation rate (%) 2009
-0.3
0.3
0.2
0.1
2.1
-1.3
5
2.8
-0.9
2010
2
1.1
1
1
2.4
-0.8
4
3.3
2
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2009
MARKET FLASH / JANUARY 2010
USA Japan Euro UK
USA Japan Euro UK
Euro Dollar Dollar Yen Euro Pound Sterling Brent Gold
FINANCIAL FORECAST Money-market rates / NAM June 2010 0 - 0.25 0.1 1 0.50 - 0.75 Fixed income 10-year rates / NAM June 2010 3.60 - 4.00 1.3 -1.6 3.40 - 3.80 3.80 - 4.20 Currencies / NAM June 2010 1.40 - 1.45 93 - 96 0.85 75 - 80 1150 -1200
December 2010 0.25 - 0.50 0.1 1 0.75 -1.00 December 2010 3.70 - 4.10 1.3 - 1.6 3.50 - 3.90 3.90 - 4.30 December 2010 1.35 100 0.85 75 - 80 1150 -1200
Allocation 2010 : new era or relapse? By Franck Nicolas, Head of Global Asset Allocation at Natixis Asset Management
n A two-stage investment strategy Natixis Asset Management expects its investment strategy to have two main aspects in 2010, in view of below-potential growth in developed countries (though with consolidation continuing), more dynamic growth in emerging countries and in the absence of inflation and atypical monetary policies.
• Prioritizing diversification and stock picking After two particularly directional phases of falls then rises, there should be an asset decorrelation, and diversification could be more advantageous from the standpoint of the risk-reward profile than in 2008 or 2009.
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Source: Bloomberg - Calculations: Natixis AM
MARKET FLASH / JANUARY 2010
0.9 35.0% MSCI US volatility, annualized Average inter-sector correlations on the MSCI US 0.8 30.0% 0.7 0.7 Average correlations for returns on 7 asset classes over 1 year (rolling basis) 25.0% 0.6 0.6 (Developed country equities, Emerging market equities, 20.0% 0.5Global government bonds, High-yield US, Commodities, 0.5 0.4US real estate, Hedge funds) 15.0% 0.4 0.3 10.0% 0.2 During these periods, high-risk assets were very closely 0.3 0.1 wonder whether tightening would be appropriate (dilemma 5.0% correlated and had to be combined in very variable 0.2 0.0 between a regulatory adjustment due to a return to growth 0.0% 96 97 98 99 00 by 01 inflation 02 03 fears). 04 05 While 06 07valuations 08 09 proportions (between 0% in 2008 and 100% in 2009) with or caused solely are
0.1
government bonds (generally Bunds). 0.7 0.6
reasonable, they do not exceedSource: long-term averages. Bloomberg - Calculations: NatixisIfAM
0,0 95
Average correlations for returns on 7 asset classes over 1 year (rolling basis) (Developed country equities, Emerging market equities, Global government bonds, High-yield US, Commodities, US real estate, Hedge funds)
96
97
98
99
00
01
02 03 04 05 06 07 08 09 Difference in returns between Source: Bloomberg - Calculations: Natixis AM the S&P 500 and 10Y bonds
7
ISM on inverse scale
20 25 30 35.0%35 30.0%40 45 25.0% 50 20.0%55 15.0%60 65 10.0%70 085.0%
1/P/E – 10Y Cheap 5 bond on the MSCI US bonds 0.9 MSCI US volatility, annualized Average inter-sector correlations 0.4 3 0.8 0.3 0.7 1 0.2 0.6 -1 0.5 0.1 0.4 -3 0,0 Expensive 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 0.3 bonds -5 0.2 Source: Bloomberg - Calculations: Natixis AM 86 88 90 92 94 96 98 00 02 04 06 0.1 Source: Natixis AM, Bloomberg 0.0 0.0% Now that the asset classes have to annualized fair value,35.0% 0.9 MSCI US volatility, Average inter-sector correlations on the MSCI US returned 96 97 98 99 00 01 02 03 04 05 06 07 08 09 0.80.7 specific considerations will be more important than30.0% Source: Bloomberg - Calculations: Natixis AM Average correlations for returns on 7 asset classes over 1 year (rolling basis) policy thier expected, they could 20%rates are increased earlier 0.7 systematic aspects. Furthermore, equities, Emerging market equities, the disparity in the25.0% become 0.6 (Developed country 19% somewhat expensive. 0.6 Global government High-yield US, Commodities, performances ofbonds, high-risk assets should increase. 18% 20.0% 0.50.5 US real estate, Hedge funds) Difference in returns between 717% 20 What works for asset allocation should also apply to 0.40.4 15.0% the S&P 500 and 10Y bonds 25 16% 0.30.3 ISM on inverse stock selection. Stock picking should be the priority rather10.0%Cheap 5 1/P/E – 10Y 30 15% scale 0.2 bond than a purely directional approach to the equity markets.5.0% bonds 14% 0.2 35 0.1 3
0.5
n Asset allocation
This movement should be accompanied by a lowering of 13% 40 0.00.1 0.0% Capex as % of US GDPbenchmark portfolio historical volatility, which would combine with the reduction To date, Natixis Asset Management’s 12% 1 45 96 97 98 99 00 01 02 03 04 05 06 07 08 09 0,0 Capacity utilization in implicit volatility that began several weeks ago. 11% is composed as follows: 50 95 96 97 98 99 00 01 02 03 04Source: 05 Bloomberg 06 07 -08 09 Calculations: Natixis AM -1
Source: Bloomberg - Calculations: Natixis AM
0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
00
72
78
• Overexposure to equities in… -3 65 half Difference in returns between 20 Expensive - US in particular, if the dollar strengthens in the second 35.0% volatility, annualized Average inter-sector correlations onthe theS&P MSCI500 US andMSCI -5 70 10YUSbonds bonds 25 of the year based on the interest rate differential becoming ISM on inverse 1/P/E – 10Y Cheap 5 30.0% 30 86 88 90 92 94 96 98 00 02 04 06 08 scale positive for the Fed again, in the event that US interest bond bonds 25.0% 35 Source: Natixis AM, Bloomberg 3 rates increase first, 40 20.0% 1 45 15.0% 50 20% 90 -1 10.0% 55 19% 60 85 -3 18% 5.0% 65 Expensive 17% 0.0% 70 80 bonds -5 16% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 86 88 90 92 94 96 98 00 02 04 06 08 15%
75
14% 13%
in returns between • Two-stage tacticalDifference management 20% 7
20 the S&P 500 and 10Y bonds 25 19% 5 ISM on inverse 1/P/E –viewpoint, 10Y FromCheap a18%tactical we could havescalea year 30 split bond bonds 35 essentially into two stages. The recovery is under way, 17% 3 40 but only 16%just, due to a lack of consumer confidence – a 1 45 consequence of high unemployment that will take some 15% 50 time to14%subside. Natixis Asset Management does not -1 55 expect 13% to see monetary tightening in the developed 60 -3 Capex as % of US GDP 12% this year. However, it is clear that with the current countries 65 Capacity utilization Expensive pacebonds of11%growth, this subject will come onto the agenda -5 70 00 72 90 96 86 be 88 strongly 90 92 7894 96 8498 00 by 02the 04 market 06 08 02in the 08 in 2010 and anticipated
90 12% 11% 85 00
Capex as % of US GDP Capacity utilization 72
78
70
65 84 90 96 02 08 Source: Bureau of Economic Analysis - Federal Reserve
80 75 -
Asia and the emerging countries, owing to their strong growth
70
• …at the expense of: - European equities, whose fundamentals will improve less Source: Bureau of Economic Analysis - Federal Reserve quickly; second half of 2010. Source: Natixis AM, Bloomberg - Japanese equities, still hampered by the strong yen In the first half of the year, the markets should therefore be A defensive bias will be the order of the day, favoring less remunerative, but less volatile, with volatility increasing companies capturing demand from emerging countries by 20% 90 as monetary uncertainty rises and the market starts to exporting knowledge or technology. 19% 18% 17% 16% 15% 14%
65
85 80 75
7
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85 80 75 70
65 84 90 96 02 55 08 Source: Bureau of Economic Analysis - Federal 60 Reserve
7
Source: Bloomberg - Calculations: Natixis AM Source: Natixis AM, Bloomberg
90
MARKET FLASH / JANUARY 2010
It is very clear that if restocking and cost cutting maintained, then improved margins, the gradual increase in investment spending (as overcapacity is reduced) could boost results in the next few quarters, and possibly after that
Bonds
Equities
Alternative
Currencies
Money market S-T government L-T government Indexed Credit HY Securitization Convertibles International bonds Emerging market bonds Europe Cyclical Defensive Growth Financial Small Caps US Japan Pacific Emerging markets Oil Gold Alternative Real estate Dollar Sterling Yen
= = = + ++ ++ + + + = = = + = + ++ + + + + = = ---
+ -+ = ++ + + + = + = + + + = + = + + + --
78
0.5 -0.5
83
-1.5
88
-2.5 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
Source: Natixis AM, Bloomberg
n Factors to monitor The pitfalls are numerous and the materialization of certain risks could reverse this scenario.
• Change of tack for currencies The yen seems to be clearly overvalued, sterling undervalued, and the dollar should gain some ground over the year. This gives the following portfolio: S2
73
1.5
• Commodities in the portfolio In a similar way to how it views inflation-indexed bonds, Natixis Asset Management sees commodities as being the only way to provide real protection against spiraling inflation – although this is still a theoretical situation. Growth in the gold price is likely to slow slightly over the year.
S1
68
2.5
• Highly diversified but reduced exposure to bonds We have an ongoing preference for short-dated bonds (Eonia should already have converged towards policy rates), emerging market bonds, credit and convertibles, plus a small portion of indexed bonds. At the same time, we will progressively reduce fixed-rate bonds, particularly the two-year maturities, if the recovery takes hold (see chart).
Asset class Category
10Y/2Y slope Cap. utilization rate on inverse scale
3.5
• Growth
A relapse without the ability to provide further stimulus is obviously the number one risk to this scenario.
• Company results
There are high expectations concerning an increase in turnover. Although company margins have been maintained through cost reduction, only an increase in profits through taking more orders and resuming sales would trigger an investment cycle that would reduce unemployment. Any disappointment over one or two additional quarters would spread doubt in the markets. Market confidence remains a decisive factor in sustaining the upward movement in equities and in any expansion in price/earnings ratios.
• Monetary policy
We believe it would be premature to forecast any exit policies. Monetary policies should continue to deviate from the standard for quite some time, if only to avoid the risk of deflation and a renewed downturn in the system. However, any mistakes in this area (which would send a restrictive signal to the market) or a tightening in emerging countries (if inflation peaks) would be obviously harmful for interestrate markets and for high-risk assets.
• Public deficits
As it is clear that governments have no more margin for maneuver in reflating the economy at this stage of indebtedness, spreads in the least well-regarded government bonds are coming under pressure. This would argue for the construction of a euro debt. The market might want to test solidarity between governments of the euro zone. How far might they push this?
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• Commodities prices
• The dollar
If growth increases more than expected (a hypothesis that remains an alternative scenario for Natixis Asset Management), the price of energy would quickly move towards the highs of spring 2008. This would act as another constraint for both industrialized and emerging countries, corresponding to a form of imported inflation. Although this would only have a temporary effect on price acceleration, it could do lasting damage to competitiveness in relation to emerging countries, which are both consumers and producers.
Although the Greek debt crisis at the end of 2009 quickly gave the dollar some breathing space, it was speeding on its way towards testing 1.60 against the euro. Going beyond the very harmful effects that this would have for European exports, we may wonder whether the United States might not, at some stage, be obliged to defend its currency at the expense of the recovery by raising interest rates (which remains the only possible way of defending the exchange rate).
Written on 01/ 28/2010
Disclaimer This document is destined for professional clients. It may not be used for any purpose other than that for which it was conceived and may not be copied, diffused or communicated to third parties in part or in whole without the prior written authorization of Natixis Asset Management. None of the information contained in this document should be interpreted as having any contractual value. This document is produced purely for the purposes of providing indicative information. It constitutes a presentation conceived and created by Natixis Asset Management from sources that it regards as reliable. Natixis Asset Management will not be held responsible for any decision taken or not taken on the basis of information contained in this document, nor in the use that a third-party may make of it.
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Appendix: Key questions for 2010 an answer, especially those covering industrialized countries in the period from 1946 to 2009. There is no systematic relationship between the level of public debt and growth, where government debt does not exceed 90% of GDP. Beyond that threshold, there is a significant negative impact on growth. The same analysis of public debt and inflation puts fears of excessive inflation into perspective: within the industrialized countries, there is no systematic link between the level of public debt and the rate of inflation. In other words, the authorities do not generally take refuge in a higher inflation rate when public debt has grown considerably. These results are important for the industrialized countries because in many cases a debt to GDP ratio of 90% is not far off. It always takes a long time for a banking crisis to be resolved, since crises of this nature are always accompanied by a sharp rise in public debt, which hampers growth and reins in activity over a long period.
Where will uncertainties over growth come from? The exit from a crisis is generally quick. The pick-up in activity allows – via investment and consumer spending on durable goods – the economy to improve and the recession to be rapidly left behind. However, this is not the case today. Several factors can explain the current situation:
• Adjustment is slow
This can be measured by the way in which the labor market has performed. In the US, but also in France, Spain and the UK, employment continued to contract at the end of 2009 (almost two years after the start of the recession) and the signs of a trend reversal are not yet very visible.
• Household debt
In many countries, household debt is preventing a strong recovery in spending. Consumers cannot spend more by taking on debt, especially by re-mortgaging their homes.
How can the public finances be rebalanced?
• Savings trend
Households are generally building up their savings at present.
The public finances have deteriorated in spectacular fashion, especially since Lehman Brothers collapsed. In general, the state of the public finances and the expansion of central banks balance sheets should be interpreted as a transfer of market risk to the public sector in order to mitigate the situation. When the crisis worsened, it was clear that public intervention was needed. This prevented the decline in activity and loss of jobs from being too severe. However, when the situation stabilizes, governments will have to announce how they are going to find room
• Deterioration in public finances
The rapid deterioration in public finances suggests strong constraints for the future, with governments making significant cuts to spending, as this is the most effective way of reducing budget deficits
• Prudence and modest investment
In light of the new and far-reaching uncertainties, business leaders are taking a prudent investment approach. As a result, the usual re-balancing has not taken place, and there will be no sudden decline as has occurred in the exit from classic recessions.
• Below-potential growth
GDP growth will slowly move towards potential, while remaining modest and below its long-term trend, with limited ground made up.
What are the concerns over public debt? The increase in public debt is very worrying. This could impact on growth and inflation. Recent studies on these issues go some way to providing
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for maneuver. Studies on the rebalancing of fiscal policy demonstrate this: to bring down public deficits in a sustainable way it is more effective to reduce spending than increase taxes. This rebalancing of fiscal policy has two advantages:
• it creates room for maneuver (at present, if the global economy was subject to a further shock, governments would not have the wherewithal to take action)
• the announcement and method of rebalancing the public finances will be essential for the financial markets. Any uncertainty perceived as excessive will generate higher volatility on the bond markets
This is because excess liquidity can generate inflation. The central banks prefer to take preventative action, since excess liquidity is currently considerable, and needs to be mopped up quickly. Such commitments by central banks lead to the relative stability of long-term interest rates, thereby limiting the cost of the recovery.
Will short-term interest rates rise soon? The central banks slashed their interest rates as activity slumped and inflation dwindled, as expected. These two factors reflected the marked reduction in pressure on production capacity (as indicated by the plummeting capacity utilization rates and the sharp rise in the unemployment rate) and the fall in the oil price. Given that the lack of pressure on production capacity is abundantly clear, there is no obligation on the central banks to increase interest rates. We note the asymmetries relating to the capacity utilization rate and the unemployment rate: they deteriorate very quickly, but take a long time to return to a level consistent with the pressures on production capacity. The adjustment period for these indicators is significant, whatever the configuration: whether growth is robust (but tensions arise, despite strong investment) or in the absence of growth and with the obsolescence of equipment, this takes time.
What is the activity profile? The key issue lies in the different dynamics of industrialized and emerging countries. The industrialized countries will see low activity levels in 2010, with policy remaining on the accommodative side. The imbalances caused by the crisis will only be solved slowly, especially on the labor market. At the same time, in the emerging countries, growth will be sufficiently robust to lead governments to adopt more restrictive strategies in order to limit tensions in the economy. This can already be seen in monetary policy. The different paces of growth will lead to the emergence of a new global equilibrium, in which the emerging countries will play an essential role.
For the central bankers, it is very important to absorb and neutralize all the liquidity that has been injected into the financial system as a whole. The monetary authorities are therefore putting emphasis on exit strategies (for the ECB, a reduction in long-term operations and return to variable rate operations in the spring) rather than on a particular interest rate level.
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