Austerity will be the big theme of 2011, with fiscal cuts and deleveraging providing a substantial headwind to the global recovery. The market’s focus will remain on sovereign risk, especially in the peripheral parts of Europe, including Greece, Ireland, Portugal and Spain, and the need of many governments to cut deficits and unwind some of the debt that has been amassed over the last decade.
The tightening of fiscal policy will be a drag on growth in the UK and the eurozone and ultimately there will be a question as to whether some of these countries can withstand the pressure.
As financial markets anticipated, quantitative easing has been restarted in the US. But the real surprise this time has been the impact it has had on the rest of the world. Currency appreciation and an ever-increasing risk of growth stalling elsewhere has led to tensions and raised the spectre of currency wars.
Beyond the fall in bond yields and the dollar we do not see there being much further impact from QE2 on the economy, not while banks remain reluctant to lend.
Emerging markets have fast become the destination for investors searching for yield but huge capital flows into these countries is causing liquidity problems and leading to a rise in inflation rates.
In 2011, we expect the gradual recovery to continue, with a quickening pace in the US, boosted by its expansionary policies, and strong profits and balance sheets in the corporate sector. This should lead to more spending by companies and a reduction in unemployment. In turn, this should benefit the rest of the world as US consumers start spending again.
In emerging markets, an enviable fiscal position and the desire to improve infrastructure will keep boosting growth.
Elsewhere, we expect a slowdown in Europe and the UK, mainly because of the spending cuts and tax increases, which will begin to bite more in 2011. If the euro continues to be relatively strong, growth may be so subdued that we do not see any increases in European Central Bank interest rates until 2012.
This continued recovery in growth is important for real assets but because it is not a robust recovery, interest rates are likely to stay very low as we go through 2011. Against that environment, the best place to search for yield will be in equities, lower quality corporate bonds and perhaps commodities, especially within emerging markets and Asia.
Andrew Yeadon is head of multi-manager at Schroders