Global: Fundamental Risks: What's Real, What's Priced
- excerpt from latest Goldman Sachs Research, March 21, 2007
Global: Fundamental Risks: What's Real, What's Priced
With markets still pushed about by risk appetite and positioning recently, it is helpful to focus on fundamentals. We look here at the four fundamental concerns that we hear most often: 1) A sharp slowing in US growth, 2) A tightening in Chinese policy that will choke off growth there, 3) Renewed concern that the economies of Europe and Japan will prove too weak to offset any slowing in the US, and 4) Rising inflation in the US and Asia (China and India in particular). Of the four, the issue that worries us most is the risk that inflation may not moderate as quickly as we expect. Recent signs here have been concerning, and the market has paid less attention to them than we would have expected.
Concern largely overstated. Many of the fears that are currently being voiced are probably overstated. In particular, we think the global growth picture still looks friendly and the US risks broadly in line with a soft landing. Recent developments on the activity front have generally not been unexpected relative to our own views (perhaps less so the markets!). Our US economists have maintained for some time that evidence of housing stabilisation was likely to prove transitory, for instance, while our China team has flagged the risks of somewhat higher inflation, strong growth and further policy tightening. It is precisely this combination of slower US growth but resilience elsewhere that has underpinned our relatively upbeat view of the global outlook.
The fact that markets also appear to be pricing general risk rather than specific macro concerns also reinforces our view that risk more than economics has driven the recent price action. Many of these fears are broadly aired, which also makes us more comfortable that risky assets can gradually renew their performance, as investors become comfortable that the overall economic picture may have changed less than they feared.
Renewed sign of inflation risk. The renewed sign of inflation risk was somewhat unexpected and this concerns us relatively more. While recent market chatter has focused more on growth risks, we see a return of inflation pressure as the bigger threat to our "happy slowdown" view. Next Friday's PCE will be the next hurdle to clear on this front -- and might be an uncomfortable moment for markets, at least in the short term. Our core view remains that inflation is set to moderate, but this is the issue for risky assets that we would most want to finesse or hedge, and that would threaten our benign global view most systematically.
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