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UBS expects soft-landing for the US economy

Kuala Lumpur | | Media Releases APAC

UBS expects a soft-landing for the US economy but it is left to be seen whether a soft-landing can be followed by a soft (global) take-off, said Paul DONOVAN, Deputy Head of Global Economics, UBS Investment Bank, who is in KL for meetings.

"The proximate cause for the recent market turmoil appears to have been worries that rising inflation pressures might prompt the Fed and other central banks to step more firmly on the policy brakes. Equally, investor positioning has been an important source of market movements. But even if inflation were to accelerate, the underlying investment risk remains weaker growth. The growth slowdown and how risk markets respond is therefore a major concern.

"We suspect that the Fed will largely get it right, producing a relatively gentle deceleration of growth this year. But whether the US and global economy can subsequently experience a 'soft take-off' is less certain. Replacing lost US domestic demand represents a key challenge for the global economy over the remainder of this decade," he added.

"Profit growth ought to slow as US (and global) growth decelerates later this year and in 2007. But that outcome alone says comparatively little about the asset allocation call. The behavior of risk premiums remains a critical driver of asset returns. For now, prospects remain positive, notwithstanding the recent market volatility.

Although the US current account deficit continues to widen, the nature of surpluses elsewhere is changing. Europe and much of Asia are witnessing shrinking external surpluses, with the energy and commodity-producing countries taking their place. Historical precedent suggests that a significant further dollar decline and shift in relative domestic demand growth are required to alleviate the imbalances problem. Synchronous global growth has yet to deliver the solution," Donovan explained.

"The world faces an immediate concern, which is the need to slow above-trend growth, especially in the US, before inflation and inflation expectations rise too far. Overall however, we believe the Fed will largely get it right, at least as far as the soft landing is concerned. Beyond the tactics however, lie other big issues, namely whether a soft-landing can be followed by a soft (global) take-off.

We doubt many investors are yet focused on this issue, but it ought to become more pertinent because the key pre-conditions - higher real interest rates and the need for tighter fiscal policies - are here or arriving soon," he concluded.

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