Rod Davidson, head of the fixed-income team at Alliance Trust Asset Management, has been managing money, teams, and businesses in the global fixed-income arena for more than 20 years. Prior to joining Alliance Trust Asset Management he held similar posts at Scottish Widows Investment Partnership, Aberdeen Asset Management, and Murray Johnstone. He specializes in managing global bond and currency portfolios and has responsibility at Alliance Trust Asset Management for macroeconomic research, duration strategy, and currency strategy.
What are the primary risks ahead for developed market economies?
For the United Kingdom, our forecast for GDP expansion is positive for 18 months and beyond. However, the global economy has now worked its way through the first phase of the recovery process and there are an increasing number of worrying signs that the rate of growth is slackening off. The fiscal deficit burdens of Western economies, allied to record levels of government debt, have created headwinds that are being exacerbated by weak housing and labor markets and a depressed consumer market.
One consequence of this is that it has created sustained anxiety among investors. The way this plays is that, despite the scale of government debt issuance and the historically low yields, there has been no shortage of investors in the major government bonds as people and institutions seek shelter for their assets in low-risk government debt.
As a result of this dynamic, strong demand and the very low short-term rates, yields have been able to edge down markedly from March through to September 2010 for UK, US, and German bonds. Even in Japan, where the yield on 10-year government bonds is extremely low at just over 1%, there is strong demand since they have a negative core inflation rate of –1%.
The negative economic signs, however, are a cause for concern. There are clearly real concerns about the sharp deterioration of the US housing market that was experienced by the end of the third quarter of 2010. Earlier, in the second half of 2009 and the spring of 2010, the US housing market benefited from an attractive tax credit. Initially this boosted sales to first-time home buyers, but it was extended to include existing homeowners who were buying.
The downside of this stimulus was always that it might simply bring forward sales that were going to happen anyway, creating a dearth of sales when the tax credit was withdrawn, and this is now happening. It is difficult to see how the housing market in the United States can recover until the economy is able to create large numbers of new jobs. The picture ahead, for some time to come, looks like being dominated by weak demand stemming from weak consumer confidence and weak consumer spending.
This throws the burden for global growth on to China, which needs to deliver a relatively healthy rate of growth at around 8% or higher to help the global economy to recover. Today, policy-makers in China are wrestling with measures to cool a developing bubble in the Chinese housing market, while at the same time seeking to maintain growth in fixed-asset investment. The strategy for doing this has been to shift the focus of infrastructure investment toward the central and western regions of the country, where development needs and opportunities remain high.
There are significant imbalances within the Chinese economy that need to be addressed, however. Developing economies with a major export-generated surplus tend to be characterized by a disproportionate share of GDP coming from infrastructure investment rather than from consumer spending. China’s infrastructure spend accounts for 45% of GDP, three times more than the equivalent spend in the United States, which is just over 15% of GDP. Longer term, there is a very pressing need to see the GDP share of household consumption rise markedly.