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Central Banks to Stay Looser for Longer 

Andreas Utermann 

2014 Global Market Outlook 


Global CIO Andreas Utermann discusses his economic outlook for 2014, including the role of central banks in shaping capital markets, the effects of a prolonged period of financial repression and the risks and opportunities for investors.
Key Takeaways
Central bank policy will continue to surprise financial markets by remaining looser for a longer period than markets expect.
For the first time since 2008, a moderate global cyclical recovery is in progress.
Risk assets will drive returns in 2014 against a continuing background of financial repression.
“... investors should carefully review their long-term exposure to risk assets in the hunt for attractive long-term returns, using market weakness or corrections as buying opportunities.”

-Andreas Utermann
Global CIO
Overall, we see a reduction in the presence of extreme risks to the global economy with the existing risk factors posing no significant threat. This provides a stable and positive backdrop for the global economy in 2014, with the prospect of economic data continuing to improve in the new year. Despite the fact that the temporarily resolved debt-ceiling debate in the United States could trigger continuing uncertainty among investors at the start of 2014, we believe that the global economy will continue to recover, albeit moderately. That said, investors need to be prepared for markets to continue to be primarily driven by the fiscal and monetary policies implemented by global central banks, led by the US Federal Reserve.

The massive global injections of liquidity that central banks have pumped into the global financial system since September 2008 have simply not filtered through into the real economy.”

As we enter the sixth year after the global financial crisis, the world’s economy continues to stabilise. This economic recovery, however, has been built on the back of quantitative easing (QE) by the Fed and other central banks, with “the end of QE” remaining a sensitive subject. The prospect of rising prices triggered by QE continues to be depressed by stagnant wages and falling oil prices. These forces are likely to remain in place in the near future, although deflation poses a greater threat in the short-term. In the long-term, however, inflation risk will probably increase if central banks leave it too late to apply the brakes to current monetary easing policies.

The Fed faces a real balancing act, as it considers when to start winding down the existing programme of purchasing Treasuries.”

The market reaction in the form of severe “taper tantrums” earlier this year confirmed the suspicions of many investors: the global economic recovery remains dependent upon QE and the Fed underestimated the severity of the market reaction in the form of rising bond yields and the selloff in emerging markets. Following such events, central bankers planning future policy should be far more mindful of taking into consideration both inflation and the fragility of the global financial system.

Lessons for Investors
In the current market environment, and given the fact that we have falling inflation rates in most of the developed markets, central banks are likely to continue to surprise financial markets by being looser for longer, reflected in central bank policy:


Fed tapering policy:

- The Fed made it clear in 2013 that it intended to taper QE policies but, as we predicted, the tapering policy in practice has been far less aggressive than the market anticipated.
- The Fed wanted markets to react positively to this less aggressive easing and it clearly does not wish to see asset prices deflate at a time when it is trying to reflate the real economy.

European Central Bank
(ECB) policy:

- Recent ECB policy also confirms our belief that we will see looser monetary policy for longer from global central banks. The recent ECB announcement of a new rate cut in the euro-zone provides further proof of this.

Investors should be aware that central banks are likely to be very cautious when implementing tighter monetary policy in developed markets. We expect them to carefully consider market sentiment and then implement the necessary policies to surprise asset markets on the upside.

Regional Markets at a Glance

United States

Should investors fear the prospect of higher interest rates in 2014?
The decision to taper the Fed’s bond purchase programme, which the Fed announced earlier this year, marked a critical turning point. As a 30-year bull market for bonds has drawn to an abrupt end, investors should be wary of investing in longer-duration bonds. In the short-term, the possibility that Treasury yields could fall remains in anticipation of a delay to tapering, but we should expect to see the yield on 10-year US Treasuries stabilise between 2.7%-3.5%.

We do not expect a rise in US interest rates in the short-term. On the contrary, investors should be prepared for central banks around the world to be willingly behind the curve in terms of both timing and the magnitude of eventual interest rate hikes – as long as inflation expectations appear well anchored – possibly for an even longer period of time. Investors would do well to note that this is further proof of how critical central bank policy and actions will continue to be for financial markets in 2014, with no change in sight at this point in time.

Although the latest debt-ceiling compromise was reached at the last minute, and represents only a temporary fix to the still unsolved problem of the unsustainable US debt burden, it nevertheless sent out an important signal. The fact that both political parties managed to find a compromise in the end showed that, under sufficient pressure, politicians could reach a longer-term agreement to tackle the US debt burden. The Fed will certainly not want to endanger the positive market mood with any further comments on a final winding down of its bond-buying programme. With inflation remaining subdued in the United States, there is no immediate pressure on the Fed to act. And we can expect to wait until the first quarter of 2014 before we hear further announcements on tapering from the Fed.


As the recovery broadens, Europe returns to growth after years of crisis.
After years of crisis-ridden headlines in the euro zone, the seemingly eternal debt crisis appears to be easing at last. We believe that this trend is here to stay and will continue into 2014, lending support to European markets - unloved and under-owned by investors for so long.

The progress made by Ireland, with its expected return to the capital markets in 2014 and exit from the existing external support mechanism, will send an important signal to market participants that there is a light at the end of the euro-zone debt crisis tunnel. It will also encourage the likes of Portugal and Spain to remain on track implementing fiscal and structural reform.

Greece, which remains the weakest peripheral country, will need at least one more round of restructuring before it can hope to embark on a lasting road to recovery. However, the latest forecasts show that green shoots are clearly emerging, even in this crisis-battered country, with Greece now expected to return to 0.6% growth in 2014 and 2.9% growth in 2015, according to the latest winter 2013 European Commission forecast. That said, with structural reforms in many peripheral countries still unpopular and painful in the short-term, investors should be aware that the risk of a political backlash in the euro-zone remains a significant threat, as does the chance of further euro appreciation. This can be seen in the long road to recovery in Spain and Portugal, where both countries have made genuine progress in implementing deep, long overdue, structural reforms that have sent real positive impulses through the wider economy.

Despite progress, however, the recovery in many peripheral countries remains fragile, as can be seen in Spain, where the European Union (EU) has just revised its original 0.9% forecast down to 0.5% for 2014. Even though larger economies, such as France and Italy, also continue to struggle to implement deeper reform and to shrink their debt burdens, we still believe that the euro zone will continue to recover, which, together with planned ECB policies to stabilize European banks, should have a positive effect on the euro-zone economy as a whole, with a banking union in the EU finally becoming a more realistic prospect.

Emerging markets

Prospects set to improve after weakness
After a prolonged period of weaker economic growth in emerging markets, there are signs of recovery in the air with countries such as China and Poland particularly well positioned to benefit from the wider recovery in developed markets.

From a structural perspective, we continue to believe that carefully selected emerging-market stocks offer investors the prospect of attractive long-term returns. Even though some of these stocks are not cheap at the moment, it is worth considering investing in companies in developed markets, which are well positioned to benefit from the best growth opportunities in emerging markets. In addition, emerging-market currencies and bonds offer investors the possibility to invest in those countries with positive demographic trends and low levels of government debt.


Recovery in Japan unsustainable in the long run
Despite having the best intentions with the introduction of “Abenomics”, we believe that the Bank of Japan’s expansive monetary policy, designed to fight weak growth and deflation, has only limited prospects of long-term success.

Weakening the yen alone will not solve the deeper problems of stagnant economic activity. Deep structural reforms to encrusted structures are needed to really kickstart economic growth on a sustainable, long-term basis. If current efforts by Japan’s central bank are not successful, then Abenomics could grind to a halt within the next two years.

Investors should consider that, in the short-term, expansionary monetary policy could further weaken the yen, which would boost the equity market in Japan. Japanese bonds could also profit in the short-term, with the central bank declaring its intent to take the majority of sovereign debt onto its books. However, as soon as expansionary policy in Japan is reduced, we would expect the yen to rise again and government bond yields to sink, with a negative impact on what are currently optimistically high share prices.

Global Economic Recovery

We believe that there is a cyclical economic recovery underway in the global economy, but that it will be a modest, more muted recovery in 2014. We are not going to see globally synchronized economic growth that will result in central banks suddenly significantly tightening monetary policy. Therefore, the environment is going to be very similar to the last two to three years, when fears of eventual tapering get replaced by fears of inflation. However, the concern about deflation is greater today, but markets are relatively buoyant despite these fears, supported by justified confidence that central banks are going to continue to keep monetary policy looser for longer.

Equity dividends as key driver of equity returns

Our advice to focus on equity-dividend strategies as a more defensive investment in volatile markets has proved to be a wise strategy in previous years, with these stocks delivering superior returns to global indices. In 2014, our conviction continues to be strong in companies that have the proven ability to grow their dividends in a sustainable manner, based upon robust, flourishing business models that are gaining market share in all market conditions. We believe that dividends are set to continue to be a key driver of overall equity returns in the year ahead and investors should consider using market corrections or periods of weakness as a strategic opportunity to add to long-term positions within their portfolios.

Biggest Risks in 2014

Currency wars, financial repression and politics

Tensions around the valuation of global currencies have increased in 2013 and could worsen further in 2014 as aggressive QE policies are maintained. The significant weakening of the yen as well as the US dollar, which has reached its lowest level in trade-weighted terms for many years, are starting to cause significant friction within the global economic community. China continues to face accusations by the United States that it’s manipulating its currency (downwards) and continued claims from the euro zone that it’s running an increasing current account surplus. Markets should be mindful, as we have warned in the past, of the potential for these developments to turn into a full-blown currency (and trade) war. In addition to currency wars, and as previously discussed, the interim resolution of the US budget impasse and continued political uncertainty surrounding the euro zone both carry the possibility of unsettling the markets in 2014.

Investing in riskier assets

With most investors continuing to park their assets in what are perceived as “safe”, highly liquid short-term assets, financial repression poses the highest risk to these investments in the longer-term. With government debt relatively expensive and set to deliver lower returns, the prospect of higher inflation poses an even greater threat to what investors have traditionally regarded as safe investments. In the longer-term, investors looking for higher, inflation-beating returns are likely to be forced to look to equity markets at last, with equities proving to be one of the few asset classes able to deliver the capital returns needed. Equities are less likely to be impacted by unsustainable levels of sovereign debt and are set to benefit from a longer-term recovery in the global economy. We believe equities will continue to offer investors the most attractive long-term returns in 2014. Careful stock selection, based upon fundamental analysis, is key to selecting a well-diversified and broad portfolio of stocks.

Source of all data: Allianz Global Investors, as at December 2013.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



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Watch Global CIO Andreas Utermann discuss his global market outlook, including how central-bank policies will influence asset prices, the biggest risks for investors and where cash sitting on the sidelines should be put to work.
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