Today is the anniversary of the birth of Rabbie Burns, while we celebrate with offal food, it is worth reflecting on his poem “to a mouse”, which contains the verse “but Mouse, thou art no thy lane, in proving foresight may be in vain. The best laid plans o’ mice an’ men, gang aft agley. An’ lea’e us nought but grief an’ pain, for promised joy”.
However, despite this warning to forecasters fund managers must make fundamental assessments of the global economy and the Ignis Rates team recently published their outlook for 2012; Jeux Sans Frontiers, Markets with Tears, which contained our central view of more volatile weak growth, with the global economy experiencing sub-optimal outcomes as politicians grapple with a series of prisoners’ dilemmas in Europe, Asia and the US.
The path of official growth data over this period is likely to be determined by the ability of statisticians to accurately accommodate the increased seasonal economic volatility in the wake of the credit crunch. We are not hopeful and therefore anticipate stronger than expected activity during the first quarter, which will repeat the pattern of the past two years with the added boost from the mild winter weather. But seasonally adjusted daffodils don’t bloom in spring and the sun doesn’t shine in summer (statisticians lead such exciting lives) and we expect global activity to weaken sharply over the second and third quarters forcing all of the major central banks to expand their balance sheets significantly by the summer. The global slowdown should also be the catalyst for Greece default and further sovereign credit rating downgrades as the European recession deepens.
However, 2012 will be the Year of the Dragon and the only mythical beast in the Chinese zodiac and has special importance for the Han Chinese who describe themselves as children of the Dragon, it is a symbol of power, but it also brings uncertainty and change. For some the change is expected to be catastrophic, but suggestions that the Mayan prophecy can absolutely predict the end of the world on December 21st are absolutely rubbish. Nevertheless in honour of these deluded apocalyptical visions, the naturally bearish Ignis Rates team have addressed their annual Dr Pepper’s Guide – What’s the Worst that Can Happen in terms of the four horsemen of the apocalypse. The list is not meant to be exhaustive, we did not predict the Japanese earthquake last year or the subsequent nuclear disaster, and the impact of these extreme events is generally shrouded in uncertainty and misinformation. For example the impact of the Japanese earthquake on the local and global economy would have been much greater had the authorities acknowledged the meltdown of three of the reactors at Fukashima.
The four horsemen of the apocalypse are white, red, black and pale each signifying conquest, war, famine and death. Conquest represent the positive upside risk for the global economy posed by the fact that the US financial system is in better shape than the European banking system. In our opinion this makes US banks the best horses in the glue factory, rather than poised to return to the economy and the treasury market to 1994 conditions. Nevertheless, the impact of this tail risk on global government bonds would be brutal, but it would also imply the end of deleveraging of consumers, corporates and government. We do not believe that this has happened and the process has several years more to run. A premature end to deleveraging would represent the conquest of banking over economic history.
The second horseman represents war. The succession risk in North Korea represents a risk, but China and South Korea are determined to avoid provocation. This abstinence of provocation does not apply in the Middle East where Israel and America are trying to contain Iran’s nuclear and geopolitical ambitions through sanctions and a not so covert war on Iranian scientists. Iran is content to play the long game over US disengagement and will seek to avoid a war that it cannot possibly win. However, the economic hardship produced by sanctions as well as parliamentary elections on March 22nd and increased rhetoric means that when dealing with the military the best laid plans of donkeys and lions are vulnerable. Any conflict is likely to be short, lasting no more than a few months, but the impact of elevated oil prices on the fragile global economy is likely to be extremely damaging forcing an even greater reaction from central banks.
However, we view this third Gulf war as less likely than the next currency war. Europe needs growth, but Germany is not willing to finance this growth, which means that it must be borrowed from somebody else through currency weakness. We expect the €uro to fall to $1.15 by the middle of the year. This sharp drop from $1.45 last August will provoke a reaction from China and Japan, who will seek to weaken their own currencies, which in turn will increase the incentive for the US and UK to accelerate their quantitative easing. These competitive devaluations will spark a race for the bottom and reduced international cooperation, but it is also a world where gifted amateurs need not apply.
The perception that global growth is a zero sum game is driven by the paradox of thrift as new western economic orthodoxy and traditional eastern mercantilism combine to favour savings over consumption. We believe that this consumption famine will lead to growth-recessions across developed and developing economies and recession in Europe. However, there is a key risk that the export orientated developing economies under-estimate the weakness of developing economies and are slow to relax policy, pushing their economies deeper into recession.
This risk would clearly be enhanced if we see the fourth horseman. The pale rider signals death and in the context of 2012 this represents the death of the €uro. We believe that the single currency will stumble through 2012, albeit with the loss of one member Greece. To lose one member might be regarded as misfortune and to lose two looks like carelessness but three would be fatal for the single currency. This is a risk but not likelihood in 2012.
Chief Economist, Co-Fund Manager
Jan 26, 2012 at 4:22pm