The key to reading markets is, of course, to understand surprises, the unexpected. What actually happens in markets is never predictable, otherwise those who are good at using financial analytics would always be right, and they almost never are. A report by Macquarie attempts to look at some possible surprises for next year, which is a worthy exercise. They posit seven: central banks expanding monetary policy, Chinese growth slowing, foreign investment into Asia falling, the RBA tightening monetary policy, Australian consumers re-leveraging, the two speed economy reversing, and … no surprises in 2012.
Of these seven I find the first perhaps most interesting:
“With conventional monetary policy tools increasingly exhausted, several central banks have had to cast off their traditional conservativism and get creative in recent years. Academics, analysts and central bankers themselves have therefore spent considerable time in proposing new policy targets, in an effort to get the economy onto a stronger growth track, with ideas such as nominal GDP growth targets, or targeting a much higher inflation rate than the customary 2% among them.
Along these lines, it is possible that the US Federal Reserve throws caution to the wind and nominates an unemployment target. That is, it promises not to tighten monetary policy until the unemployment rate falls below, say, 7%. The level of the unemployment rate target would be close to, but above, the unemployment rate below which wage pressures are thought to emerge (generally known as the Non-Accelerating Inflation Rate of Unemployment or NAIRU).
The advantage of this would be that it provides more certainty for firms wondering about whether to invest. For example, it removes the risk of higher interest rates occurring while demand growth is still sluggish.”
America’s big corporations are extremely cashed up, with about 1 trillion sitting on their balance sheets. If the Fed can convince them that the Fed is convincing, there is the potential for a revitalisation of the US economy, which is already looking healthier. The world economy may become more US-centric, especially if surprise 3 kicks in:
“Foreign direct investment into Asia has fallen to its lowest level in about 20 years, but portfolio investment and other investment (such as trade credits) have kept overall investment positive in the last year. Those last two components are, however, much more volatile than foreign direct investment, and so with European banks looking to deleverage it is possible that overall foreign investment could be surprisingly weak in 2012.”
Personally, I think the biggest surprises could come from a more aggressive China, moving closer to a float of the yuan. I continue to think that, if the euro survives, that would be a major geo-economic shift because it could reduce the power of the greenback as the world’s reserve currency. It is widely expected to occur after 2015, at the earliest. There may be some surprises on that front.