Strategy Report

Expectations For The World Economy Going Forward

The global economy is expanding again, led by growth in China and other emerging markets that have shown surprising resiliency through the economic crisis.  So far, the recovery has been founded on liberal stimulus efforts taken by the world’s governments and central banks.  Initially, these drastic measures were essential to preventing a recession from turning into a depression and perhaps falling into a true financial collapse.  However, the debt and deficits cannot be supported for long; and this support is therefore only a temporary safety net.  In this transition period where growth has not been fully established and rates are still extraordinarily low, we are nonetheless seeing a building interest behind speculation.  In the fray, the benchmark U.S. dollar, due to low interest rates and ample stimulus that has led to cheap money, has taken up the mantle of primary funding currency through a revival of the carry trade.  However, many of the dollar’s peers hold similar benchmark interest rates and the expectations for returns are therefore very low.  With time, growth will solidify and interest rates will eventually rise; and with such a tangible fundamental foundation, carry interest will build, trends will develop and volatility will settle.

Taking a look at the 12 month growth and interest rate forecast for the industrialized world, there is a good probability that speculative interests and rates of return will be significantly higher in a year’s time.  Economic growth should help the credit markets stabilize and capital will return to the private sector to once again provide funds for capital-intensive projects.  As this occurs, central banks will likely coordinate a removal of quantitative easing and begin to hike interest rates around the globe.  Banks, borrowing at higher rates, will lend money to high-yielding projects to ensure that the more expensive terms of their loans are met.  Two years ago, when economic growth was strong and interest rates high (Fed Funds rate over 5%), lending was met with high-quality private-sector borrowers expecting strong returns in the bull market.  Over the past two years, however, the economy has slowed and the credit markets have frozen up.  Central banks reacted to this situation by loosening monetary policy to provide more liquidity to the markets, yet much of this liquidity provided to banks has been placed in reserves as most lending has appeared too risky and volatile in the trying economic times.  If growth expectations are met going forward into 2010 and interest rates are higher, quality capital should once again make its way into a profitable private sector.

Written by James Russell, CFDTrading Research
Please send any comments about this report to JRussell@fxcm.com