FYI | May 10 2007
By Chris Shaw
There is no doubt takeovers and corporate activity are currently driving global equity markets, but supportive economic conditions are playing a role in generating strong enough global growth to ensure corporate earnings are sufficient for the financial engineers to find opportunities.
Given the level of corporate activity currently going on it is a good time to step back and assess the global economic outlook for the next year or so and Danske Bank has obliged with its view on how things stand.
Chief economist Carsten Valgreen points out while the slowdown in the US housing sector has been attracting a lot of attention given the potential impact on the US and global economies there are two reasons investors should not be unduly concerned.
Firstly, Valgreen notes the rest of the world economy is performing well, with both the European and emerging markets recording solid growth. Secondly, he points out it remains unlikely the housing slowdown in the US develops into something more serious, as to date the US economy has shown it is coping fairly well with the housing downturn.
In addition, there are some signs emerging the housing sector itself has hit or is close to a bottom, so there is still a chance US economic growth for the year will achieve near-trend levels despite a weak first quarter.
While US manufacturing has been in a slowdown since the middle of last year there are also signs of improvement here, Valgreen expecting data through spring to show a slight up-tick, which is further evidence of his view the US economy overall remains solid.
Strength in Europe has seen the European Central Bank (ECB) lift rates to levels of around 4%, which Valgreen suggests is a neutral level. While expecting two further rate hikes this year he suggests there is no need for the bank to move to tight rates, so any further increases are likely to take longer to flow through and the bank is likely to become more data dependent rather than moving pro-actively as has been the case.
Looking into 2008 he suggests the biggest concern is there is now little room for growth in most economies, as current low unemployment levels are inconsistent with price stability. He expects this will make central banks increasingly nervous, so while interest rates may be subdued in many markets this year the risk remains to the upside going into next year.
This will impact on currency markets, with head of FX research Teis Knutsen pointing out the recent trend of the global economy being conducive to risk taking can be expected to continue. This means currencies supported by high relative levels of interest rates, such as the Australian and New Zealand dollars and the British pound should continue to be attractive, while low yielding currencies such as the yen and Swiss franc find little support.
In Japan in particular this trend shows no signs of easing, as Knudsen notes households in Japan are moving assets into overseas markets, creating an outflow of capital. This capital outflow is also the reason behind the recent weakness in the US dollar, as strength in the European economy and the potential for further rate hikes (the bank expects two further increases in official rates by September) are likely to see the euro strong against the greenback.
Turning to 2008 he suggests a potential theme is a sharp tightening in global liquidity conditions, a scenario that suggests conditions next year may be far more supportive for the low yielding currencies than is currently the case.