The world economy is set to improve, but there is still a lot of slack. These conditions give global equities ‘running room’.
T he sharp fall in European sovereign spreads has stopped the bleeding in the euro zone economy, but the recession has not yet ended. Meanwhile, the decline in the yen has raised expectations of better nominal growth in Japan, although the economy remains extremely moribund, with all key macro indicators still contracting. In addition, the U.S. and China are in a far better situation than one year ago, albeit uncertainty remains.
All of this suggests that the world economy will probably continue to operate at a pace that closes the output gap very slowly. This assessment is supported by the global inflation picture, which is either low or falling.
Under this scenario, monetary policy will stay ultra easy and both nominal and real interest rates must stay low. Periodic currency realignments not only redistribute growth among nations but also become a key barometer of relative monetary stance.
This creates a “sweet spot” for equity investors – modest growth, low inflation and negative real rates will support corporate earnings and embolden risk taking. (tweet this!)