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Second-Quarter Outlook: Tail Risk Reduced, Crisis Remains

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( BBH FX Strategy) -- The world looks quite a bit different here at the end of the first quarter than it did at the end of last year. The combination of stronger U.S. growth and the aggressive liquidity provisions by the European Central Bank has effectively pushed the global economy away from the abyss it was facing at the end of 2011.

The reduced tail risk does not mean that the financial crisis is over. In fact, there are many signs that the crisis continues, albeit at a lower level of intensity. Household deleveraging, for example, which restrains the cyclical recovery in the world's largest economy, remains evident. More than half of the deleveraging that has taken place appears to be a function of mortgage foreclosures. The resolution of outstanding legal issues warns that after a hiatus in 2011, foreclosures are set to rise again.

In Europe, the sovereign and bank roll-over risks have been reduced, but the periphery of Europe is not yet on a sustainable debt path. Even Greece, which has restructured its debt and is receiving a second round of assistance, is not out of the woods by any stretch of the imagination. In fact, the pricing of Greece's debt is consistent with market fears that another aid package will prove necessary.

From a larger perspective, the dysfunction of the financial system is still evident. The money multiplier, which is the linkage between central bank high powered money and money supply, has broken down and shows little improvement.

The investment climate in the second quarter remains fraught with risk. After the U.S. posted above trend growth in fourth-quarter 2011, it appears poised to slow considerably in the first quarter. A further slowdown in the second quarter could revive ideas of another round of asset purchases by the Federal Reserve.

Our base case calls for a soft landing in China, the world's second-largest economy. There is some risk of a harder landing that would have knock-on effects for countries that export to China as well as on commodity prices in general.

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