• Cyclical economic slowdown on the cards in the US

The cyclical recovery seen since mid-2009 seems to have obscured the fact that reducing over-indebtedness is a highly deflationary and potentially very slow process if it is not facilitated by an appropriate economic policy. There is thus increasing pressure in the US for an immediate return to fiscal virtue and, at the same time, for a less expansionist monetary policy. The scheduled end in June to the Fed’s liquidity injections and the likelihood of a less growth-orientated budget could thus come on top of the deflationary effects of higher oil prices and a possible cyclical slowdown that can already be detected from a number of leading economic indicators. Fortunately, the calls for a scaling back of stimuli by authorities may be thwarted. From a fiscal perspective, the US presidential elections on the horizon could hold things back until end-2012. In terms of monetary policy, the scepticism shown by the Fed Chairman as regards the underlying health of the US economy will ensure that at the very worst monetary policy normalisation will be very gradual even if it is pretty clear that the massive liquidity injections will cease at end-June. 

• In Europe, the ECB’s monetary tightening will weigh on the weakest eurozone countries

The current growth has markets feeling that the recent measures taken to help struggling countries will be enough to get the eurozone through the crisis. The political backing for the European project is undoubted, but can the public finances of the member countries being bailed out and the political backing itself survive the cyclical slowdown underway, the rise in ECB rates that is further weakening Spain, the strengthening of the euro that has amplified deflationary risk everywhere except in Germany and oil prices that won’t come down any time soon? We have our doubts. Thus, even if the risks weighing on developed economies are not all imminent, there are lots of them. The coming end to QE2 may well see investors factoring them into their valuations of mature equity markets. 

• The issue of inflation is in the process of being resolved in emerging countries

Emerging countries do not have to deal with the problem of the withdrawal of fiscal and monetary stimuli. On the contrary, it would appear that the end of QE2 in the US will reduce imported inflationary pressures there and will facilitate their monetary and foreign exchange policies. Any future rate rises will be less frustrated by unwanted inflows of foreign capital, thereby enabling a more effective fight against inflation, optimised by a controlled strengthening of their currencies. Similarly, the inflationary effects on agricultural prices of the La Niña weather phenomenon will gradually subside, with the appearance of favourable base effects over the coming months. Unless there is further disruption in the oil supply, the issue of inflation thus seems to be in the process of being resolved in emerging countries, all the more so in that the expected slowdown in the mature economies will help reduce pressure on industrial commodity prices.

• Emerging countries enjoy continued growth momentum, further driven by domestic demand

Unlike developed countries, the emerging universe continues on its own economic cycle, unconstrained by over-indebtedness. In our core scenario, inflation will not undermine emerging market growth but will stabilise at levels above those seen before the 2008 crisis. In addition, the spreading of a possible slowdown in developed countries to the emerging universe would in no event be comparable to that seen in 2008, when emerging economies and markets were hit particularly hard for at least three reasons. 2008 resulted from a sharp drying up of global liquidity, which naturally had more of an impact on areas and assets deemed to be more at risk. In addition, exports to developed countries, which were in crisis, were a major growth driver for many emerging countries, which is less true now, with notably no expected contribution from Chinese net exports to GDP over the coming two years. Finally, stock markets in emerging countries had outperformed mature stock markets for ten consecutive years. Now, most emerging markets, with China at the forefront, have seen a period of underperformance and seem to us to be less vulnerable. 

• Risks are concentrated in the developed universe

In the current climate, the balance of risks is thus very much against the developed universe. The recovery in developed countries is undermined whereas control of inflation in emerging countries no longer seems to depend solely on oil price fluctuations. The current climate thus argues for ongoing confidence in the emerging universe and for investments in developed countries that are indexed to emerging market growth or defensive in nature.