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Manufacturing around the globe is strengthening, with the index increasing in 16 out of 25 major economies in January. As a consequence, commodity prices are on the rise, which is adding to inflationary pressure. Unrest in the Middle East has pushed up oil prices. As long as stability in Saudi Arabia is maintained, the impact of the current crisis is likely to be limited. Tensions in the eurozone have declined as European leaders chose a more proactive stance.
We expect earnings, increasing M&A activity and loose monetary policy to continue to drive equity prices. The eurozone debt crisis will undermine sentiment from time to time. A muddling-through scenario is likely to develop, as there is simply no willingness yet for a fiscal wealth transfer mechanism.
Corporate-bond spreads continue to tighten, thereby delivering attractive returns. How far can this rally go? We feel it can go significantly further, given our expectation of moderate economic growth and a muddling-through scenario in the eurozone debt crisis. Default rates are low and upgrades of credit ratings are outnumbering downgrades. We do not think that valuation will hinder further decent performance.
Government bonds are not attractive on a longer-term horizon but we do not expect a significant rise in longer yields in the short term. The message from core inflation rates is not at all alarming, with the exception of the UK. Capacity utilization rates generally leave sufficient room for production to rise quite easily, while unemployment is high enough to prevent labor cost inflation.
The outlook for commodities is positive, as supply is having difficulties in meeting the growing demand. This longer-term underlying trend is now coinciding with stronger producer-confidence data, increasing the likelihood of further rises in commodity prices in the short term.
In a special feature, we argue that China’s efforts to increase the profile of the yuan reflect the country’s increasing self confidence. But China’s currency is still far from being a real alternative to the dollar.