'A tricky balancing act' says Barclays Wealth economics research

12 October 2009, London

The global economy has shown increasing signs of turning around over the summer

The October edition of Barclays Wealth Signpost is entitled A tricky balancing act

Michael Dicks, Head of Research at Barclays Wealth, said:
"The global economy has shown increasing signs of turning around over the summer, helped by massive policy easing by central banks and finance ministries around the world. Riskier asset classes, such as equities and corporate bonds, have recovered as a result - much as we expected them to. Now, the key question for investors is how sustainable the rally is going to prove to be. We remain optimistic that better-than-expected macro-economic data, and a strong recovery in corporate profits, should help - along with the powerful momentum in markets - to sustain rallies through the fourth quarter. When it comes to 2010, however, policymakers will find it tougher walking the tightrope, balancing between providing sufficient stimuli to ensure that the recovery continues while preventing not only inflation but the creation of new asset price bubbles."

Over the summer, confidence has grown that the global economy is turning around, with emerging markets leading the way. Asset prices are reflecting this shift.
In fact, the strength of the recovery in GDP for the next quarter could be slightly greater than is generally expected and, along with momentum, this may help support riskier asset classes.
But, looking forward to 2010, the outlook for consumption in the developed economies might cause some concern, and is one of the key points to watch in the current recovery.
Real wages in the US will be about flat at best, as high unemployment keeps downward pressure on wages and rising headline inflation boosts the cost of living.
Public finance concerns will also force a switch from fiscal easing to fiscal tightening in some countries, with the change of stance being particularly sharp in the UK.
So, while we believe that inflation fears are overdone, we think doubts about the sustainability of above-trend growth will increase as 2010 unfolds, with riskier asset classes struggling to make further headway.

Gustavo Reis, Senior US Economist, added:
"After an 18-month long recession, the US economy experienced a jump in activity in the third quarter and we're expecting the manufacturing and housing sectors to continue to contribute to the recovery through the remainder of the year and into 2010. The consumer will be key, regarding both the longevity and strength of the expansion next year. Policymakers face a tough transition, as they first plan and then implement their exit strategies."

Economic update: US

The US economy hummed again in the third quarter, probably posting GDP growth in excess of 4% in annualised terms. Resurgent activity in the manufacturing and housing sectors epitomised the post-recession rebound.
Although growth will slow again towards year-end, the recovery should persist through 2010 - helped by continued policy support which has stabilised financial markets and buoyed auto and housing demand.
As confidence has strengthened, market participants' focus has shifted to the Federal Reserve's "exit strategy". We look for rate hikes in Q4 2010, but risks are skewed towards an earlier move.

Sandra Horsfield, Senior Euro area Economist commented:
"The euro area appears to be coming out of recession, in the sense of GDP being likely to have expanded a little in the third quarter. But is not yet out of the woods. For the labour market stands to continue deteriorating for some time. And rising unemployment will dent households' income and encourage higher savings. All in all, the euro-area economy looks set to experience an only feeble recovery at best."

Economic update: Euro area

The euro-area recession appears to have come to an end, insofar as GDP growth - already only mildly negative in Q2 - looks likely to have turned positive in Q3, judging by the improving trend in "hard" short-term indicators.
But a strong bounce in output beyond that caused by the inventory cycle is improbable, as balance sheet repair is likely to take priority over investment and consumers' incomes stand to be hurt by still-rising unemployment.
Inflation is on the verge of turning positive again, but core inflation may well be pulled further below the ECB's target level due to rising spare capacity and unemployment. Therefore, rate hikes look unlikely until late 2010.

Michael Dicks, Head of Research, said:
"While the UK economy appears to have emerged from the recession, we are anticipating a rocky road ahead. The monetary stimulus is unlikely to be withdrawn. But fiscal policy is likely to be tightened perhaps aggressively following next spring's general election."

Economic update: UK

The UK economy appears to have emerged from recession during the third quarter and is likely to record positive growth before the year is out, perhaps even in Q3. However, recovery is likely to be muted.
CPI inflation has fallen throughout the past year, but at a slower rate than many expected. We expect it to start creeping higher from the fourth quarter onwards, but to remain below the Bank of England's (BoE) 2% target.
We doubt that monetary policymakers will be quick to tighten policy, given the soft foundations of the recovery. But fiscal policy looks set to be restricted, perhaps harshly so, following next spring's general election.

Asset classes

One valuation approach to equities, based on GDP trends as the driver of underlying "fair value", suggests that there may be further upside. Momentum in share prices is likely to be positive, but weaker, than seen recently.
As central banks focus on their exit strategies, creating uncertainty, bond yields will move higher. UK gilt prices will not be supported indefinitely by the Bank of England's gloom and gilt purchasing programme.
Credit spreads continued to narrow during Q3, and much faster than expected, thereby closing most of the gap with our gauge of their fair value. Looking ahead, spreads should continue to narrow, but at a rather slower pace.
Global real estate markets have risen by more than 70% since their early-March lows. US and UK commercial property markets now appear nearly fairly valued again, with Europe and Japan a little "dear".
Volatility in FX markets fell substantially over the summer. But it is likely to increase as economies recover. We expect the dollar to remain under pressure in the coming months.