At the beginning of 2000 we expected GDP growth to continue to strengthen in the first half of the y...
At the beginning of 2000 we expected GDP growth to continue to strengthen in the first half of the year, prompting further tightening of monetary policy in the US and Europe, which would eventually dampen the speed of the global recovery.
This continues to be our view, particularly in the US. In this context, US GDP consensus forecasts, which have moved from 2.6% at the beginning of this year to 4.8% more recently, now appear over-optimistic. Monetary policy obviously operates with a lag and we believe conditions have been put in place which will result in a sustained economic slowdown.
Nevertheless, comments made by Greenspan in his recent speech to the Senate Banking Committee surprised us. Greenspan spent much of his speech providing reasons why the economy should slow and why productivity growth will remain strong. This sent a strong message to financial markets that the onus is on the economic data to convince him that the slowdown is more transient and inflationary risks greater.
Looking forward, therefore, our central scenario is for the Federal Reserve not to raise short-term rates in August unless economic data sends a decisive signal that further tightening is needed.
Although we expect a small cyclical upturn in inflation, brought about by a reversal of previously disinflationary factors, we do not predict that inflation data ahead of the meeting will be sufficiently strong to push the Fed into action. Energy-induced increases in inflation will not be seen as a major threat to economic stability as long as inflationary expectations are not impacted. Growth data will have to indicate a clear re-acceleration for it to prompt a reaction.
Longer-term the close interaction between financial markets and the real economy may result in a further tightening of monetary policy. Nevertheless, we do not expect a major upturn in inflation, as we believe that structural disinflationary forces remain in place.
As a consequence, any further tightening will be limited and a soft landing should be achieved. This environment should be supportive for both bond and equity markets, enabling them to recover through the second half of the year. Investors are however, expected to continue to experience significant volatility at the stock and sector level.
As the technology sector now represents such a high proportion of the S&P 500 index, future rallies and subsequent corrections are expected to be associated with the outlook for this sector.
In general, we believe companies within the technology sector have the greatest visibility for future earnings growth when compared to other sectors such as consumer staples and consumer cyclicals, where the visibility of sales growth is less clear and the potential for margin erosion more likely.
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