Global Economics Weekly

Issue No: 10/29

July 28, 2010 Goldman Sachs Global Economics,
Commodities and Strategy Research
at https://360.gs.com

Looking into the Second Half

Jim ONeill In our final weekly before a brief summer
jim.oneill@gs.com break, we look back over the year so far and
+44 (0)20 7774 2699 forward to the second half of the year and the Index Market Has Moved Through Three Phases Index

market themes and questions that we think 1260 118

Dominic Wilson S&P 500 (lhs)
will dominate there. While the year has
dominic.wilson@gs.com 1220 114
+1 212 902 5924 proceeded in distinct phases from US GS Wavefront
Consumer Growth
growth upgrade to European sovereign risk 1180 110
Kevin Daly to US slowdown worry many assets are not
kevin.daly@gs.com far from where they begun 2010. 1140 106
+44 (0)20 7774 5908
In thinking about this evolution and the path 1100 102
Anna Stupnytska
forward, we find it helpful to think about 1060 98
anna.stupnytska@gs.com
+44 (0)20 7774 5061
three sources of risk exposure. The first is
US growth risk and the issue of whether the 1020 94
PHASE 1 PHASE 2 PHASE 3
Swarnali Ahmed market has priced enough of a slowing. The
swarnali.ahmed@gs.com second is non-US growth risk broadly 980
Jan-10 Mar-10 May-10 Jul-10
90
+44 (0)20 7051 4009 speaking and whether the market is too Source: Goldman Sachs Global ECS Research
optimistic or too pessimistic there. Running
Alex Kelston
alex.kelston@gs.com
around this issue is whether it is possible to
+1 212 855 0684 see slowing in the US without seeing more
serious slowing elsewhere (the decoupling Index US Downside Surprises Dominate Index

Stacy Carlson debate returns!). The third is the kind of 1.2 100.6
Surprise Indices in:
stacy.carlson@gs.com systemic risk that has reappeared with 1.0 100.5
+1 212 855 0684 USA
worries about sovereign exposures and the 0.8 100.4
Euroland
banking system. 0.6 100.3
Asia ex Japan (rhs)
0.4 100.2
We think the second half of the year will be
dominated by a set of judgments that relate 0.2 100.1

to these three areas. First, how deep a US 0.0 100.0

slowing and what kind of policy response -0.2 99.9
might be forthcoming? Second, how much -0.4 99.8
decoupling is possible (and will Chinas -0.6 99.7
policy shift meaningfully)? Third, will
-0.8 99.6
sovereign and systemic risks intensify again Jan-09 May-09 Sep-09 Jan-10 May-10
or settle? Our own forecasts envisage a Source: Goldman Sachs Global ECS Research

period of some muddiness in the near-term

that ultimately resolves towards a more
positive global view. But given the fragilities
in the system, we will be watching our
various proprietary tools (GLI, FSI, FCIs)
and trying to stay open-minded.
This is our last Global Economics
Weekly for the Summer. We will
resume publication on September 1.

Important disclosures appear at the back of this document

Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly

Looking into the Second Half

In our final weekly before a brief summer break, we look
back over the year so far and forward to the second half
of the year and the market themes and questions that we
think will dominate there. While the year has proceeded
in distinct phases from US growth upgrade to European
sovereign risk to US slowdown worry many assets are
not far from where they begun 2010.
In thinking about this evolution and the path forward, we
find it helpful to think about three sources of risk
exposure. The first is US growth risk and the issue of
whether the market has priced enough of a slowing. The
second is non-US growth risk broadly speaking and
whether the market is too optimistic or too pessimistic
there. Running around this issue is whether it is possible
to see slowing in the US without seeing more serious
slowing elsewhere (the decoupling debate returns!). The
third is the kind of systemic risk that has reappeared with
worries about sovereign exposures and the banking
system.
Most asset classes are a mixture of all three risk
exposures, but the mix varies widely. In terms of our own
views, we continue to think that US growth risk is not
fully reflected and that the downgrade to US growth
views that the market has been making takes us only part
of the way to where we need to be. In contrast, we still
find ourselves more upbeat than consensus on the non-
US growth picture. Particularly as concern deepened in
May and June, we have also found ourselves on the more
benign side of the debate about the impact of sovereign
and system risks, though the issue is unlikely to disappear
and there are plenty of political road-bumps that could
resurface in the months ahead.
As a result, we have argued that we want to be short US
growth risk, long non-US growth risk and to try to earn
systemic risk premia. For now this has pushed us
towards relative trades between the US and the rest of the
world in equities and FX, and a preference for earning
risk premium through parts of credit. We have also begun
to look more positively again at broad EM and China-
related exposures.
We think the second half of the year will be dominated
by a set of judgments that relate to these three areas.
First, how deep a US slowing and what kind of policy
response might be forthcoming? Second, how much
decoupling is possible (and will Chinas policy shift
meaningfully)? Third, will sovereign and systemic risks
intensify again or settle? Our own forecasts envisage a
period of some muddiness in the near-term that
ultimately resolves towards a more positive global view.
But given the fragilities in the system, we will be
watching our various proprietary tools (GLI, FSI, FCIs)
and trying to stay open-minded.
Three phases this year
We see three distinct phases in the evolution of the
markets this year. In the first phase from early December
to early April, the market was dominated by further
evidence of acceleration in the global growth cycle but
led by consistent upgrades to US growth views. European
sovereign worries flared in the background but only
briefly spilled into broader markets. Over this phase,
risky assets generally did well, but US outperformance
was clear in the performance of the USD, the
outperformance of US equity indices and of domestic-
facing cyclical stocks within the US market.
In the second phase, from mid-April to mid-May, the
European sovereign crisis intensified dramatically and
funding stresses, systemic risk and concerns about
Europes political and economic health came to the fore.
The sharp rise in volatility, a blow-out in peripheral
European sovereign spreads, a further rapid decline in the
EUR and intense pressure on global asset markets were
the major symptoms. Reinforcing this process were
increasing signs that global cyclical indicators were
peaking.

Index First Phase of Market Driven by US Index Index Second Phase Saw Sovereign Risk and Index
Consumer Upgrade Volatility Spike
1260 118 300 50
S&P 500 (lhs)
275 Spain 5-yr CDS
1220 114 45
GS Wavefront (lhs)
Consumer Growth 250
VIX 40
1180 110 225
35
200
1140 106
175 30
1100 102
150
25
1060 98 125
20
100
1020 94 15
PHASE 1 PHASE 2 PHASE 3 75 PHASE 1 PHASE 2 PHASE 3

980 90 50 10
Jan-10 Mar-10 May-10 Jul-10 Jan-10 Mar-10 May-10 Jul-10
Source: Goldman Sachs Global ECS Research Source: Goldman Sachs Global ECS Research

Issue No: 10/29 2 July 28, 2010

Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly

% Third Phase Driven by US Slowdown Fear % Index Focus Shifted from Relative US Strength Index
to Weakness
1.5 1.9 1.50 0.0380
US 2-year swap
rate (lhs) PHASE 1 PHASE 2 PHASE 3 0.0375
1.4 1.8 1.48
Euro 2-year swap
rate (rhs) 0.0370
1.3 1.46
1.7
0.0365
1.2 1.44
1.6 0.0360
1.1 1.42
PHASE 3 0.0355
1.5
1.0 PHASE 2 1.40
0.0350
PHASE 1
1.4
0.9 1.38 International vs
Domestic equities in 0.0345
1.3 US (lhs)
0.8 1.36 0.0340
EM equities vs SPX
0.7 1.2 1.34 0.0335
Jan-10 Mar-10 May-10 Jul-10 Jan-10 Mar-10 May-10 Jul-10
Source: Goldman Sachs Global ECS Research Source: Goldman Sachs Global ECS Research

Since mid-May, a third phase generated by the
combination of an aggressive European policy response
and increased evidence of a US slowdown has been
evident to varying degrees across markets. This has been
associated with a gradual relaxation of some of the
extreme worries about sovereign risk and a greater focus
on pricing a slower US growth picture. The USD has
been weakening for nearly two months now, US equities
have underperformed both Europe and EM (with
domestic outperformance within the market also
reversing) and US yields have fallen sharply both in
absolute and relative terms.
Despite these phases, we have ended up round-tripping
in many places. US equities are almost exactly flat on the
year, as are broad EM equities, while Europe and China
have been clearer underperformers. Commodities and
broad cyclical equities (as captured by our Wavefront
Growth basket) are down a touch, while US consumer-
facing equities are still up year-to-date. And the VIX and
corporate credit spreads are a touch higher. But many
things are more or less where they started the year,
despite following a volatile path in the interim.
The most striking exceptions are in government bonds
and currencies. US 10-year yields are around 80bp below
where they began the year and US 2-year yields more
than 50bp lower and German yields have also fallen. In
contrast, Greek sovereign spreads are (even now) over
400bp wider than at the start of the year and Spanish
spreads are still close to double their starting point
(though the all-in yield has changed relatively little). In
FX, the EUR is even now 10% below where it started the
year and the JPY has also rallied sharply in line with the
fall in US rates. This means that point-to-point by far the
biggest repricing this year has not been in the markets
overall growth and risk view but in the relative pricing of
sovereign risk and a realization that policy rates will stay
lower for longer in both the US and Eurozone.
How our views have changed
This evolution has matched our outlook in places and
challenged it in others. In a series of pieces analyzing this
stage of the cycle and the post-housing bust experiences
elsewhere, we argued that 2010 would be a year in which
stocks went through a flatter period with more moderate
returns as the acceleration period in the global growth

Index US Downside Surprises Dominate Index % mom GLI Momentum vs. Global Industrial Production*
1.2 100.6 1.5
Surprise Indices in:
1.0 100.5 1.0
USA
0.8 Euroland 100.4 0.5

0.6 Asia ex Japan (rhs) 100.3 0.0

0.4 100.2 -0.5
0.2 100.1
-1.0
0.0 100.0
-1.5
-0.2 99.9
-2.0
-0.4 99.8 Global Industrial Production*, 3mma
-2.5
-0.6 99.7 GLI Momentum
-3.0
-0.8 99.6 98 99 00 01 02 03 04 05 06 07 08 09 10
Jan-09 May-09 Sep-09 Jan-10 May-10
* Includes OECD countries plus BRICs, Indonesia and South Africa
Source: Goldman Sachs Global ECS Research Source: OECD, GS Global ECS Research

Issue No: 10/29 3 July 28, 2010

Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly

GDP Growth: GS vs Consensus GLI now shows a clear peak in March 2010, it is at this
2010 2011
point still consistent with relatively robust growth rates,
% yoy 2009 GS GS (23 Dec Consensus
GS Consensus* as are the PMIs as Kevin Daly and Alex Kelston recently
(Current) 2009) (Current)*
illustrated.
USA -2.4 2.6 2.3 3.1 2.4 3.0
Japan -5.2 3.4 1.5 3.2 1.7 1.6
Euroland -4.0 1.4 1.5 1.1 2.2 1.4
What we have missed so far includes three major issues.
UK -4.9 1.3 1.9 1.3 3.2 2.1
First, we underestimated the spread of the European
Europe -3.9 1.5 1.7 1.3 2.5 1.7 sovereign crisis to broad risk sentiment (and of course
China 8.7 10.1 11.4 10.1 10.0 9.1 initially to the EUR) and the extreme resurgence of both
India 7.4 8.2 8.2 8.3 8.7 8.3 volatility and financial risk. Second, we have
Brazil -0.2 7.8 5.8 7.1 4.5 4.4 underestimated the impact of ultra-low G3 rates on the
Russia -7.9 5.8 4.5 5.1 6.1 4.7 profile of interest rates globally. While many central
BRICs 5.3 8.9 9.2 8.8 8.7 8.0
banks have seen rates rise significantly relative to the G3,
Advanced
Economies
-3.1 2.6 2.2 2.7 2.6 2.5 the absolute pace of tightening in Europe in particular
World -0.6 4.7 4.4 4.6 4.8 4.3 has been slower than we initially envisaged. In most
* Consensus Economics July 2010 Source: Goldman Sachs Global ECS Research cases, this has not been because our growth and inflation
picture ended; that yields would fall rather than rise in the forecasts have been too hawkish but because the
US as disinflation and a sub-par recovery continued; and reaction function of central banks has been different
that the unique US housing experience would see the re- (more dovish) than we expected. Third, we have been a
emergence of differentiation between the US and the rest little early to activate a view that our more robust EM
of the world and a moderate form of decoupling on that growth views would translate into better absolute EM
basis. asset performance.

With global equity markets flat, bond yields lower and Looking at the changes to our own key forecasts since the
the market shifting back towards a US slowdown, many start of the year (set out in the table), our global growth
of these features still look relevant to us. The slowing in forecasts have actually risen both for this year and next.
the US economy that we have long forecast for 2010H2 Within this, our US GDP growth views are modestly
is becoming more visible than seemed likely a few higher for 2010 and our China growth views lower. Our
months ago. European data has so far validated our views for the Eurozone are not meaningfully different
forecast of relative resilience. And while our (improved) than they were at the start of the year. But they have
remained stable alongside significant reductions to our
Bigger Changes to Rates/FX Than Equities/Growth European rate forecasts for the end of 2010 (across most
31-Dec-09 27-Jul-10 European economies) and a substantial weakening in the
Equities currency, so easing financial conditions have more or less
SPX 1115.1 1113.8
offset the impact of fiscal austerity and sovereign risk.
This pattern of revisions broadly fits the revisions that
Eurostoxx 2965.0 2769.3
markets have also made so far this year.
EM equities 100.0 99.7
China H-shares 12794.1 11931.1
WF Growth 97.2 94.8 Three risks and how to think about them
WF Consumer Growth 95.1 98.2 We have recently identified three sources of exposure
Volatility/Credit
that run through many macro assets to help us focus on
the asset landscape. The first is exposure to US growth
VIX (%) 21.7 23.2
risk. The second is exposure to non-US growth risk. The
CDX (bp) 85.5 102.5
third is exposure to systemic (and sovereign) risk, closer
CDX HY (bp) 515.6 553.4
to a pure risk premium.
Bonds
US 10-year (%) 3.85 3.08 Our own current views on these three areas are as
US 2-year (%) 1.14 0.65 follows:
German 10-year (%) 3.3 2.66
German 2-year (%) 1.35 0.87
On US growth risk, our forecasts remain firmly
below consensus on an absolute and relative basis
Spain 5-yr CDS (bp) 116 175
(recent data weakness has pushed the consensus
Greece 5-yr CDS (bp) 288 709
towards our 2010H2 US GDP growth forecast of
FX/Commodities 1.5%, but it remains above 2.5%). We do not think our
EUR/$ 1.43 1.30 US growth views are fully priced across markets. This
USD/JPY 93.09 87.90 is clearest from looking at our front-end views which
EUR/CHF 1.48 1.38 remain lower than the forwards even after the recent
AUD/$ 0.90 0.90 rally, both in absolute terms and relative to the entire
Crude Oil 79.4 77.5 G10. Benchmarking to the relative performance of US
Copper 7375.0 7059.0 equity markets, the picture is a little less clear, though
Source: Goldman Sachs Global ECS Research on a relative basis here too domestic-facing parts of

Issue No: 10/29 4 July 28, 2010

Goldman Sachs Global Economics, Commodities and Strategy Research
the US market have also looked too optimistic versus
our forecasts.
On non-US growth risk, we continue to have a more
positive view in general. Our global growth forecast
remains above consensus and we see more tightening
than the market in a significant number of the G10.
Our European growth views in particular are now
clearly more optimistic than others, as Erik Nielsen
and team have set out for some time, and the latest
data has been quite encouraging on that front. For
China, the other big market focus, we see more
deceleration in the near-term, but our medium-term
view is more constructive. In particular, we are now
watching closely for signs of a shift towards a more
supportive policy stance. China-related assets have
been heavily discounted over the last 12 months and
we think the market is not priced for the reacceleration
in growth that our own forecasts envisage. Because
EM has been tightening, the impact of some
deceleration in growth raises less of a policy dilemma
here and continued low real rates in many places may
again prove equity-supportive.
On systemic risk, we have argued for several weeks
that the heightened concern about sovereign defaults
(in Spain in particular) and about broad financial
system risk has been excessive. And our models across
asset classes point to elevated risk premia in many
places. We have seen significant compression in some
of these risk premia (and falls in volatility) from the
highs in May and June. And we doubt that the
sovereign crisis is over in any definitive sense. But
on balance our view remains that systemic risk and
asset market volatility are overpriced.
Asset market implications
Our own views can be seen through this lens. Looking at
the remainder of the year, our forecasts suggest that we
should be: positioned for weaker US growth and low
policy rates, at least on a relative basis; positioned for
better growth outcomes in other parts of the world and a
still-reasonable global growth picture, with an increasing
focus on the potential for a more positive shift in policy
in China; positioned to earn high risk premia where we
can do that in ways consistent with our growth views.
To translate these views into assets means understanding
the mix of these three exposures that different assets
deliver. In rates markets, front-end markets have the
tightest links with local domestic growth views. As per
our Sudoku models, longer-dated yields are a more
complicated mix of sensitivities to local growth, global
growth and overall risk premia. In equities, relative
performance of domestic-focused equities to other areas
is also often a cleaner expression of growth views than a
straight directional view at the index level. The relative
performance of indices particularly of EM to DM also
bears some relationship to the pattern of growth surprises
in each area.
Issue No: 10/29
Global Economics Weekly
Purer exposures to systemic risk premia tend to be
available in credit and volatility. Commodities have the
opposite flavour, providing more direct exposure to
growth views than to pure risk adjustments, though with
a global (and increasingly an EM-demand related) tilt.
FX is a more complicated mix, but relative growth and
rates views are an important driver of G10 in particular
but also beyond. And the absolute state of the global
cycle and risk premium clearly impact many of the more
cyclical and EM currencies as we have also shown in the
past.
Using that template for mapping, this mix biases us
towards relative trades in equities and FX (including a
stronger bias towards USD weakening); a cautiously
optimistic view of the overall risk picture particularly
later in the year; a preference near-term for credit over
equities and other risk assets as a more focused way to
earn elevated risk premia without excessive growth risk;
and a bias towards global growth exposures. Our latest
asset allocation views, set out in a recent GOAL
publication, embody a lot of this thinking, arguing for a
preference for credit within risk assets, a generally pro-
risk stance and using commodity exposures to access the
potential for better than-expected growth outside the US
and in China in particular.
More specifically, the same approach suggests that the
key asset market themes for the second half of the year
are likely to include:
In equities, a muddier risk picture as the market
balances slowing US growth with better news
elsewhere, but one that is more likely to resolve in
favour of higher equity markets as the year proceeds.
Continued underperformance of US exposures and a
renewed bias to seek commodity and emerging market
exposure within and across equity markets. In
particular, if expectations of Chinese growth begin to
move higher again as we ultimately expect, this should
reinforce the outperformance of EM equities that has
resumed in recent months, alongside the continued
easiness in policy in much of EM.
A renewed search for carry and credit exposures as
volatility drifts back towards more normal levels. This
drift may be punctuated by periodic bouts of sovereign
concern as political news on this front comes and goes.
In rates, continued anchoring of G3 bond yields as
policy rates remain low and disinflation continues in
the US and Eurozone. Further separation of relative
rate spreads as a number of smaller G10 markets
tighten more than priced (Sweden, Switzerland,
Norway, UK, Australia).
In FX, a renewed bias towards USD weakness
alongside renewed appreciation in Asian FX (and
other crosses with similar relative exposures like
AUD/CAD) if China-US outperformance becomes
evident again and CNY drift continues as per our
5 July 28, 2010
Goldman Sachs Global Economics, Commodities and Strategy Research
forecasts. In line with that theme, some of the split
between the G3 core and periphery currencies may
re-emerge, a trend that has been on hiatus, but that
would be more likely if risk sentiment broadly
improves further.
What we are watching
Given our view of the three key risk exposures, we are
watching the following:
1. How much will the US/world slow? Our biggest worry
is that the US slowdown will be more rapid than we
think and that policy is then extremely constrained in
dealing with it here. And that is the risk we think is
most worth seeking protection against. But despite the
recent evidence of slowing, a more moderate outcome
than our own forecasts is conceivable too. While
recent data has reinforced our comfort with our below-
consensus US forecast, the data has oscillated above
and below expectations all year, so the latest news
may overstate the deterioration in the trend just as the
March/April data likely overstated the acceleration.
Our Global Leading Indicator (newly improved) and
our regular sifting of the PMI and export data will be a
critical part of our assessment. The levels of the GLI
remain consistent with strong global industrial growth,
but the pace of recent deceleration in momentum
needs to be watched.
2. How much (and where) can the rest of the world
decouple? The latest data has been supportive of our
view of moderate decoupling, but a sharper slowing
Issue No: 10/29
Global Economics Weekly
in the US would be a challenge. A world in which
non-US growth turns out somewhat better than
expected offsetting disappointing US growth news will
feel very different to one in which we shift back from
a US to a global slowdown. Beyond the generic
question, we are particularly focused on whether
European data continues to slow less than expected or
whether inventory dynamics ultimately follow the US
pattern and whether we get further noises about policy
shifts away from tightening in China.
3. Will sovereign and system risk intensify again or fade?
This is arguably the hardest issue to handicap. We
think that the recent European policy response
including the European stress tests has increased the
chances that we can muddle through the most intense
risks. But the political challenges of dealing with the
fiscal adjustments that are needed in many places are
intense and the political calendar in a range of places
may heat up at the end of the summer. And it is too
early to be sounding an all clear on these issues.
One of the greater difficulties of macro trading in 2010
relative to 2009 and one that we always feared has
been that the underlying dynamics have tended to be less
stable and, ironically, it has been easier to envisage a
wide range of outcomes. In part, that is the nature of this
stage of the recovery, which is almost always muddier
than the initial acceleration period. Additionally, it is an
indication that the healing from the global recession and
financial crisis is still a work in progress.
Dominic Wilson
6 July 28, 2010
Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly

Equity Risk and Credit Premiums

Current Estimates for the Equity Risk Premium*

Real GDP Real Earnings Dividend Expected Real Real Bond Implied Expected Expected
Growth Growth + Yield = Return - Yield = ERP Inflation Nominal Return
US 3.0 3.0 2.1 5.1 1.2 3.9 2.0 7.1
Japan 1.5 1.5 1.9 3.4 0.6 2.9 0.5 3.9
UK 2.8 2.8 3.3 6.1 -0.5 6.6 2.0 8.1
Europe ex UK 2.3 2.3 3.1 5.4 -0.5 5.9 2.0 7.4
World 2.5 2.5 2.5 5.0 0.5 4.5 1.8 6.8
*Calculated as of 27 July 2010
Source: Datastream; real GDP grow th and expected inflation are GS Economics Research forecasts.

The US ERP has increased by 70bp since its most recent In June, our ECP was 326bp higher than the most recent
trough in early April, due to the fall in real bond yields. trough in November 2008.

% US ERP % Our ECP Decreased by 23bps in June

5
4.3 US ERP, calculated daily 4
Credit
3.9 US ERP 200 Day Moving Average relatively
3 1985-1998
average expensive
3.5
2
3.1 1

2.7 0

2.3 -1

1.9 -2
2 standard deviations
1.5 band
-3
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
Source: GS Global ECS Research Source: GS Global ECS Research

I, Dominic Wilson, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by
considerations of the firms business or client relationships.

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Issue No: 10/29 7 July 28, 2010

The World in a Nutshell
THE GLOBAL ECONOMY
OUTLOOK
UNITED STATES It is now reasonably clear that real GDP growth
dropped below its 2.5%-3% long-term potential range
last quarter. We expect Q2 growth of 2% (annual
rate), followed by a further deceleration to 1.5% in
both Q3 and Q4. This slowdown is happening just
ahead of the loss of growth support from fiscal
stimulus and the inventory cycle that we have been
anticipating would occur at mid-year.
JAPAN Our real GDP growth forecast is +3.4%yoy for 2010
and +1.7%yoy for 2011. Exports and production have
slowed as the yen has appreciated in response to the
expected US slowdown. Domestic consumption has
held up well but has been concentrated in durable
goods, supported by government subsidies. Once their
subsidies end, there is no guarantee of sustained
consumption. Meanwhile, the labour market seems to
be over the worst.
EUROPE Europe should continue to benefit from the stronger
global growth environment. We expect EU-27 real
growth to be 1.5%yoy in 2010 and 2.5%yoy in 2011.
For the Euro-zone, we forecast growth at 1.4% in
2010 and 2.2% in 2011. However, the cyclical
position of each country is different. While Euro-
zone Q1 GDP disappointed us, we think a good deal
of the overall shortfall was caused by the weather
and will therefore show up in Q2.
NON-JAPAN ASIA In China, we have lowered our real GDP growth
forecast to 10.1% for 2010, from 11.4% previously.
We have not changed our view of the trend level, and
therefore once policy loosens, growth should quickly
revert to trend. Thus, we have kept our 2011 GDP
forecast unchanged at 10%. For Asia ex Japan we
forecast 8.7% and 8.4% growth in 2010 and 2011.
LATIN AMERICA Our LatAm growth forecast is 5.8% for 2010 and 4.7%
in 2011. Our view is optimistic due to an encouraging
global outlook, continuance of easy policy in the
advanced economies, our expectation that global
liquidity will lead to capital inflows to LatAm, and high
commodity price forecasts.
CENTRAL & EASTERN CEEMEA activity data has slowed in recent months
EUROPE, MIDDLE EAST as industrial momentum has tapered and regional
uncertainty has increased. We have revised down
AND AFRICA some of our forecasts in the region, but most still
remain above consensus. The economies with strong
balance sheet structures and easy financial conditions
are expected to maintain strong growth.
CENTRAL BANK POLICIES
CURRENT SITUATION NEXT MEETINGS
UNITED STATES: FOMC The Fed cut the funds rate to a range August 10
of 0%-0.25% on December 16, 2008. September 21
JAPAN: BoJ Monetary The BoJ cut the overnight call rate by August 10
Policy Board 20bp to 0.1% on December 19, 2008. September 7
EUROLAND: ECB The ECB cut rates by 25bp to 1.0% on August 5
Governing Council May 7, 2009. September 2
UK: BoE Monetary The BoE cut rates by 50bp to 0.5% on August 5
Policy Committee March 5, 2009. September 9
Issue No: 10/28 8 July 21, 2010
KEY ISSUES
With various headwinds to private-sector growth
(excess vacant housing, state and local budget
stresses, lack of lending, reluctance to hire) still firmly
in place, we expect real GDP growth to slow in the
remainder of 2010, and we worry that reacceleration
in 2011 will not occur as now projected. Despite these
growing downside risks, US authorities (including Fed
Chairman Bernanke in recent testimony) do not
exhibit much urgency to apply more policy stimulus.
The DPJs flagship policy of child-care allowance
started in June, but its economic impact is uncertain.
With the new Prime Minister in place, conditions may
allow Japan to progress on its taxation system and
fiscal challenges. The government announced its long-
term fiscal reform plan, calling for a cap on JGB
issuance, and hence a natural cap on spending
growth. Prime Minister Kan has become vocal on a
future consumption tax rate hike before the July Upper
House election.
The stress test results provided more disclosure but
lower estimates of required capital than the market
expected. We think the large amount of information
on European banks is helpful and should increase
transparency and help ease funding stresses. This
should help the ongoing gradual healing process of
the European financial system. Additionally, our
analysis shows that bank exposures to sovereigns
in Southern Europe, Ireland and Greece are
manageable.
Our forecasts for China assume the current policy
tightening measures remain in place at least for
another month, and then some loosening is likely in the
three months starting from August. These measures
include continued credit rationing, direct administrative
controls on certain heavy industrial producers, and
tightening measures on the property sector.
We have lowered our Brazil growth forecast to 7.8%
yoy in 2010. Although the lagged effects from strong
policy stimulus should continue to boost domestic
demand growth, recent data has been slightly weaker
than expected. We also reduced our IPCA inflation
forecasts to 6.0% in 2010 and 5.7% in 2011.
In Hungary, disagreements between the government
and the IMF/EU over 2011 fiscal targets pose a
potential risk for the region. Looking further ahead,
some of the job losses in Russia, Hungary, Turkey
and the Czech Republic during the crisis may prove
permanent, owing to the relative rigidity of their labour
markets.
EXPECTATION
We expect the Fed to keep the funds rate
near 0% through the end of 2011.
We expect the BoJ to keep the policy rate
at 0.1% through 2011.
We expect the ECB to keep the policy rate
on hold until a 25bp hike in 2011Q2.
We expect the BoE to begin hiking in
2010Q4 and continue to 3.0% by end-2011.