LONDON, 10 May 2004 — Led by the US and Asia the world economy seems to have established a recovery. The IMF now predicts 4.6 percent growth on a global basis this year, compared with 3.9 percent in 2003. Most data suggest that the US economy has grown at a pace above 4 percent since the start of the year.

Meanwhile, growth on the Asian mainland has been particularly beneficial for Japan. Indeed, it is the stronger exports that helped to explain why the present Japanese upturn is more powerful than previous ones, in 1993-95 and 1999-2000.

Europe is clearly lagging, but mainstream forecasts show growth rates for 2004 around 1.5 percent for Germany, France and Italy and considerably higher rates for the Nordic countries, the United Kingdom and Spain.

With ongoing economic recovery and a spike in oil process, US inflation numbers have come in on the high side. Even the “core” CPI rose 0.4 percent in March. Markets have promptly moved to discount a monetary tightening in the US. Forward rate curves suggest perhaps a half point rise in Fed funds by the end of August and a further 1 percent increase by this time next year.

I suspect markets are factoring in too high a probability to interest rate rises in the near-term. Monthly data for US inflation and unemployment are volatile, and last month’s “bad” numbers could be followed by better ones. Also, the frequent criticism of monetary policy is that it tends to be too-little-too-late, perhaps because the authorities do not want to unsettle markets too much. Why should this time be different? The consensus today shows that the investment environment has changed in a fundamental way over the last 3 to 4 years. From the early 1980s, the global economy was in a disinflation phase, whereby falling interest rates produced returns for both stocks and bonds, which were well above the long-term average. The turning point was probably the very aggressive US monetary policy introduced in early 2001, following the US stock market crash of the previous year. We cautiously agree that the new environment reflects an era of deflation.

This also reflects some powerful headwinds, notably very high asset prices, i.e., stocks, government bonds, housing etc. Were asset prices to “normalize “ relative to income streams (such as growth in nominal GDP) or, in the case of equities, relative to book values, then perceptions of wealth could decline substantially, with a savage impact on spending and dampening price pressures.

Such concerns may help to explain why we have an equity allocation of just 30 percent, despite a recovery which is still in its early stages so far as the global economy is concerned. We are cautious also about bond markets.

In order to generate attractive returns in the present low interest rate/high asset price environment, I wish to emphasize two areas: First, higher yielding or lower rated bonds, where we look for a return of around 6 percent to 10 percent over the next year and second, low-risk fund of hedge fund type vehicles. Generally speaking, such investments can profit from a general pick up in market volatilities over the next few months.

(Habib F. Faris is vice president at Clariden Bank, London)

(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden bank makes no representation or warranty as to the accuracy, reliability, or completeness of the information)