Tags: IMF | WEO | scenarios | defensive

US Is One of the Better Places to be in a Bad Neighborhood

By    |   Tuesday, 09 October 2012 12:59 PM

Be careful. That’s the message the International Monetary Fund gave us today when it released its updated World Economic Outlook (WEO) report.

While it starts off sounding like an outright S.O.S. call, when you dig deeper into the 250-page report it becomes even gloomier.

The report states that recent, as well as today’s, WEO forecasts and Global Financial Stability Report (GFSR) baseline scenarios might “once again” turn out to be overly optimistic, even when we are already sliding further and further downward on the global economic growth path.

The IMF also warns real risks exist, as the eurozone could well, especially now that German Chancellor Angela Merkel has reiterated Greece will remain in the eurozone, slide back into the “weak policies” (yes, plural!) scenario, which would cause deleterious consequences to the world as a whole, including of course the European Union and the eurozone in particular.

Investors should take notice of the IMF’s “lower-growth scenario,” which assumes potential growth of 0.5 percent lower than the baseline for the United States and the European Union, 0.25 percent lower for Japan, 1.0 percent lower for emerging Asia and 0.5 percent lower for Latin America and all other countries. Under the lower-growth scenario, we would have to wait, which means uncertainty will be with us until at least mid-2015 before it should become clear that potential growth everywhere will remain lower than all the actual baseline scenarios until the end of 2017. The United States and Japan look a little bit better and should return to positive growth relative to their respective baseline scenarios in 2016.

The vast majority of advanced economies, of which the most vulnerable and dangerously contagious is without a doubt the European Union, will have to face debt-sustainability challenges, which would translate into higher sovereign risk premiums. Lower-growth prospects for developing and emerging economies would probably cause concerns about the viability of some private investments in these economies, as well as raise risk premiums in the corporate tradable sector.

Among a lot of other consequences, lower global growth would undoubtedly mean lower demand for commodities. Over the next three years, if no geopolitical shock(s?) occurs, the IMF sees 30 percent lower oil prices and 20 percent lower non-oil commodity prices. But having no geopolitical shocks is a big ‘if.’

The WEO and GFSR baseline scenarios assume that:

• European policymakers apply, which will also means accept, policies that will allow sound easing of the financial conditions for the eurozone peripheral countries and literally peg, once and for all, true “credibility” on all their undertakings, and

• The United States will avoid the full application of the drastic automatic tax increases as well as spending cutbacks that are scheduled to come into force at the end of the year.

I’d like to add that it’s good to keep in mind that Germany, under today’s leadership, will not allow any form whatsoever of a full EU fiscal transfer mechanism or a full banking union, which the eurozone badly needs but doesn’t serve Germany’s interests. I don’t think Germany will change these positions, even after the national elections next October.

Long-term investors would do well to ask themselves which of these two key or even both uncertainties will get a solution in time before it’s too late. I personally can’t see wonders happening in the European Union.

Besides, I remain with my view that the United States, as well as the dollar, remains one of the better places to be in a bad neighborhood, at least for now. I certainly wouldn’t bet on the dollar collapsing in the near term. It’s also a fact the vast majority of the economically important central bankers in the world would not allow a collapse of the dollar because of their own domestic interests and they certainly wouldn’t hesitate engaging in a new round of currency wars, which we certainly don’t need now.

Nevertheless, in the United States, which is now the most urgent uncertainty, we’ll have to wait and see if we will have to face, before the year is over, a stalemate on the debt ceiling and/or the fiscal cliff in Washington after the presidential elections. In my opinion, long-term investors should remain defensive until uncertainties disappear, and yes, that could still be some time away.

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Be careful. That’s the message the International Monetary Fund gave us today when it released its updated World Economic Outlook (WEO) report.
Tuesday, 09 October 2012 12:59 PM
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