• Risk appetite has been rising despite bad news on the economic front as investors put their faith in central banks. Recent action by the US Federal Reserve (the Fed) and the European Central bank (ECB) has reduced some of the tail risks in the world economy and narrowed the premium investors require to hold equity and credit.
• We are not changing our forecasts for the US this month and remain wary of the looming fiscal cliff. Nonetheless, the open ended nature of the Fed’s commitment to growth (the Bernanke “put”) could lift animal spirits and, alongside the progress being made in the housing market, creates an upside risk to our forecast. We do however caution on the outlook for corporate earnings given the extended level of the profit share.
• Asian and commodity-dependent economies would bear the brunt of a Chinese hard landing, with Western nations more immune due to lower export exposure. In addition, the disinflationary impact of a hard landing would provide a support for real incomes in the advanced economies.
UK: The productivity puzzle & the fiscal shortfall (page 8)
• The UK labour market seems oblivious to the UK being in a double-dip recession. Employment growth has been strong despite weakness in almost every part of the economy. Could higher than usual employment growth suggest a better underlying story for the economy?
• Some clues to the productivity puzzle can be found in the composition of new employment. Most of the new jobs created have been down to a rise in self-employment - which tends to be less productive. Where the traditional hiring of employees has occurred, it has mostly been of part-time workers. In addition, lower than expected insolvency rates may be to blame for poor performing firms surviving longer than they should.
• Finally, there has been a noticeable shortfall to date in the public finances. This presents a difficult choice for the Chancellor ahead of the Autumn Statement. Should he tighten fiscal policy further to make-up the shortfall, or should he be prepared to miss his own fiscal targets. The performance of Gilts suggests there is room for some fiscal slippage.