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UBS Global Asset Management: Fed Facilitating A Controlled Descent, Or Prompting A Sugar Crash?

THE UBS GLOBAL ASSET MANAGEMENT Cyclical Market Forum, held quarterly to discuss three plausible economic scenarios and their potential implications for investments over the next 12 months, found its 2Q13 Forum dominated by discussion of the ripple effects of the US Federal Reserve Bank’s move to taper or end its quantitative easing (QE) program. Three market scenarios are proposed at each Cyclical Market Forum and debated by UBS Global Asset Management (UBS) investment teams with combined assets under management of more than USD 632 billion worldwide.

While previous Forums had addressed concerns over the eurozone sovereign debt crisis situation and the US “fiscal cliff,” this quarter’s largest focus was monetary policy. The Forum participants debated the extent of the Fed’s power to maintain control over the pace of rising yields, suggesting that a gradual rise in the 10-year US Treasury yield could be supportive for certain asset types over the next 12 to 18 months, but that a rapid spike in yields could cause extensive volatility in equity and fixed income assets. Amidst this backdrop, participants were encouraged by more positive economic data in the US, although they were concerned with slowing growth in China and other emerging markets, and saw discouraging signs in Greece, Portugal and Spain.

UBS Cyclical Market Forum 2Q13 Economic Scenarios Under Consideration
  • Scenario 1, “More of the same”: An intermediate scenario, in which US government spending cuts and tax hikes continue to restrict consumption and investment, and a reduction in fiscal austerity in the eurozone only partially offsets the effects of tight lending conditions. In this scenario, US GDP growth remains steady but modest, although economic data gradually improve throughout 2013. Aggressive monetary policy in Japan continues to support growth and produces a limited increase in inflation. China continues its rebalancing process, and growth expectations remain on target.
  • Scenario 2, “More of more”: The most bullish scenario, in which investment and consumer spending in the US pick up as housing, employment and income figures improve. In this scenario, quantitative easing and global fundamental improvements lead to rapid growth and sustainable inflation in Japan. The eurozone returns to growth in mid-2013 as the periphery countries begin to recover. In China, an increase in both domestic and external demand keeps GDP growth at about 8.5%. Easing programs in China and the US are gradually scaled back without disrupting growth.
  • Scenario 3, “More of less”: The most bearish scenario, in which the eurozone remains in a recession until the end of 2014 due to tight lending conditions and deleveraging. Falling housing prices and stress in bank balances in Spain, the Netherlands and Slovenia keep sovereign markets volatile. US GDP growth stays close to 2% in response to sluggish business investment and reduced government and consumer spending. Weak external demand pushes Chinese growth down to just above 6%. Growth in Japan remains subdued, with trade flows lagging expectations.

Roughly half of the Cyclical Market Forum participants voted Scenario 1 as the most likely. Slightly more participants voted for the bearish Scenario 3 than the bullish Scenario 2 as the second-most likely scenario. Participants’ expectations of year-on-year global earnings growth were more pessimistic than last quarter, with a majority of participants seeing 0% to 5% earnings growth as most likely.

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