Outlook for H2’2012 (Developed Markets)

U.S.: Remains likely to outperform

The U.S. economic recovery lost momentum in H1’2012, however with moderate employment gains in recent months and a pick-up in the pace of consumer spending; I expect real GDP growth to increase to trend thorough H2’2012, in spite of the events in the E.U. -- I remain of the view that the transmission mechanism of the European crisis to the U.S. economy are relatively limited. My view on the U.S. economy is further anchored on improving confidence in both businesses and households across the U.S., as well as slower deleveraging, which should allow the saving rates to ease. Housing demand has increased noticeably in 2012, but the overhang of unsold homes and the tide of foreclosures have scuttled a speedy revival in residential investment.

I expect the medley of the aforementioned factors to spur growth in H2’2012, driven by private-sector demand rather than by policy. In fact, I see fiscal consolidation in the U.S. as a possible drag on growth with the risk of excessive fiscal tightening in 2013 still to be addressed. Moreover, long-term fiscal sustainability in the U.S. remains to be achieved, and a credible fiscal plan is needed to ensure it.  Given the still fragile recovery, monetary policy should remain accommodative, but conditional upon other developments. Given the foregoing, I do not expect a moderation in fiscal policy to significantly offset the gains in private sector activity in H2’2012. Furthermore, I have adopted a cautiously optimistic, view of the U.S. equity markets in H2’2012, while being mindful of the risks.

Europe: Outlook remains negative

Activity in the E.U. stagnated in Q2’2012 after contracting at the end of 2011 and Q1’2012. Unemployment has risen consistently through H1’2012 and is set to rise further in H2’2012, owing to weak confidence and difficult financial conditions related to the sovereign debt crisis. Provided that policy actions are sufficient to improve confidence, activity should begin to recover gradually in the H2’2012, notwithstanding fiscal consolidation and private sector deleveraging across the region. However, I am not optimistic that this view will materialize. Rather, I anticipate that E.U. policymakers will muddle through H2’2012 with a series of half measures (the result of a sustained failure to reach consensus) that will prove inadequate to thoroughly resolve the region’s problem. Accordingly, I expect a divergence between moderate growth in creditor countries (particularly Germany and France) and, weaker/delayed recovery in countries with large debt overhang, even as the large margins of spare capacity across the region moderate inflationary pressures. The main risks to this outlook for the region in H2’2012 centre’s on a possible intensification of the debt crisis and the economic effects of high public and private indebtedness. Though recent decisions have significantly increased the capacity of Europe’s firewall to address government funding problems, I remain of the view that it remains insufficient and fraught with regulatory handicaps. With these constraint in view, I expect monetary conditions to ease further in H2’2012 – possibly in the form of a 25 bps cut to the ECB’s prime rate. With the scope for monetary and fiscal stimulus limited, reforms to labor market institutions, product market regulations and the tax system needed to sustain growth and boost jobs, I retain the view that European financial markets are likely to underperform their developed market pairs.