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Saturday, December 31, 2011


Economic predictions for 2012: Bank of America and the other market risks

As we move towards the new year and the end of a very chaotic 2011 in the markets, global economy, and in nations dealing with social unrest, it is time to look at the economic predictions for 2012.

We will continue with the predictions made regarding other market risks outside the mainstream in 2012, as issued on December 19th by Martin Mauro at Bank of America.

The “other” risks in 2012

As markets focus on Europe as the primary risk for the 2012 outlook, we highlight four more risks that could sneak up on investors in 2012. These risks have persisted or become worse over the course of the year, but have escaped market attention due to the spotlight on Europe. While our base case does not assume a flare-up of these risks, these could potentially be the unwelcome surprise of 2012.

1. Hard landing in China

Ting Lu, our China economist, expects a soft landing in China in 2012. There are two key risks that he outlines to this expectation: rapidly falling property investment under severe government restraints, and a much worse European sovereign debt crisis.
Therefore, a hard landing in China next year would have a disproportionately high impact on the already shrinking world growth expectations. Beyond the direct effect of a slowdown in China, the impact on its numerous trade partners could intensify the blow.

2. Currency wars (competitive currency devaluation)

Treasury Secretary Geithner warned China early in 2011 against the risks of not allowing its currency to appreciate quickly1. Demands to label China as a currency manipulator have repeatedly been voiced in the US Congress. While the Chinese yuan has appreciated gradually since late last year, the rate of appreciation has been only about 6% - a rate that Secretary Geithner expressed dissatisfaction with in his remarks.

Overall, the weakening global growth environment that we expect next year could very well trigger a race to competitive devaluation by major central banks in an attempt to boost their economies.

3. Middle East oil supply shock

The uprising in Libya earlier this year demonstrated how inelastic the demand curve in the oil markets can be in the short run. As Libya’s 1.6 mn b/d of supply was removed from the market, Brent oil prices spiked by over $20.

Our economists expect economic growth to start slowing next year on fiscal tightening and consumption pullback, and an oil supply shock in such an environment could materially worsen the outlook.

4. Municipal default fears

Readers will recall market concerns at the beginning of 2011 over municipal defaults. However, with the rally in Treasuries and the long duration of municipal debt, munis turned out to be the best performing asset class this year as the anticipated multiple defaults failed to materialize.

We still hold our view that the risk of widespread defaults is low, but more high profile defaults could rekindle market concerns, especially in an environment of economic downturn. – Bank of America via Zerohedge

All of these predictions carry the potential for a very harsh 2012 in the global markets, but in particular, with the economy of the United States. Going into 2012, the dollar has rallied strong against most other currencies, while oil has slowly fallen below its highs of $105, and this has led to a deflationary period in prices for everything but food, which continues to rise on inflationary fears in certain commodities. With China's growth slowing abruptly, emerging markets appear to be moving towards recession at a time when the Euro Zone continues to struggle with liquidity issues and massive debt.

Markets rely on many things to justify growth or recession, and this includes many subbordinate indicators such as the ones outlined here by analysts with Bank of America. How they affect the overall markets going into 2012 is yet to be determined, but their impacts will definately be felt in one or more sectors and foundations of the global economy.

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