The Mayan calendar ends on the 2012 winter solstice, and although astrological developments may fan anxiety in some quarters, investors will have more pressing concerns than the “end of days.” The debt crisis that began in mid-2007 is not over. It has morphed and mutated, and in the coming quarters we will continue to reap the seeds we sowed in the mispricing of risk over the course of several years.
This will be the dominant characteristic of the investment climate in the period ahead, and it has several implications. It means policy rates will remain near zero, with scope for the European Central Bank (ECB) to lower its key repo rate below the 1-percent floor seen earlier in the crisis. It means some countries, such as Australia, will extend the easing cycles that began in 2011. It means other central banks, especially in the UK and Japan, will continue to rely on unconventional measures, such as asset purchases.
When adjusted for inflation, or inflation expectations, interest rates in the U.S., Canada, Germany, and the UK will remain negative. Negative real interest rates are the result of low nominal rates as a function of weak economic activity, safe-haven flows, purposeful policies by central banks, and elevated commodity prices. They are the bane of fixed-income investors, who struggle to preserve the purchasing power of their capital.
Although negative interest rates make competitive investments (such as equities) more attractive, the political and economic climate is not conducive for aggressive risk taking. The first part of 2012 will likely see all or significant parts of the Eurozone contract. The U.S. will remain mired in slow growth that barely stabilizes the labor market, with a politically unacceptable level of unemployment. Households’ ability to draw down savings (which dropped to 3.3 percent in September 2011 from 5.8 percent in June 2010) to fuel consumption in 2012 is limited.
On the income side, wages are not keeping pace with inflation. In terms of household wealth (housing and financial assets), 2011 was a drag. The housing market may be showing some preliminary signs of stabilization, but it won’t be an engine of growth in coming quarters.
Reconstruction spending in the public and private sectors in Japan may help soften the downward drift, but growth in the world’s third largest economy will be too slow to contribute much to the global economy. The inflation associated with higher commodity prices and the supply disruptions from last March’s earthquake-tsunami tragedy has proved to be temporary, and Japan’s underlying deflationary forces, arguably exacerbated by the strength of the yen, are reclaiming their grip.
|
|