IHS reviews global outlook

Reader Alert: This is the first of a three-part report on IHS Global Insight’s discussion on the Eurozone sovereign debt crisis. This installment covers IHS chief economist Nariman Behravesh’s analysis of some of the key features of the global outlook and IHS director of sovereign risk Jan Randolph’s probability mapping of four often-discussed near and medium-term outcomes for the Eurozone.

Two-speed world: The year ahead

According to Behravesh, the U.S. economy “has picked up steam and is going to grow quite a bit faster in 2011 than we originally thought. We were originally thinking about 2.5%; now we’re thinking it’s going to be over 3%—maybe as much as 3.5%.”

“Europe and Japan are slowing a little bit, so from that perspective the U.S. will grow quite a bit faster—maybe twice as fast.”

Behravesh also expects emerging markets will “also slow a little, but continue to grow much faster—three times faster—than the developed world.”

“This two-speed world will determine a lot of things, especially interest rates and inflation. Rates are on hold in the G7, by and large. We’re looking at interest rates at or very close to 0% for an extended period.”

“We think the earliest there will be a major move in terms of interest rates is probably in the second half of the year and more likely in the fourth quarter of this coming year. Whether we’re talking about the U.S. or Europe or Japan, I think the story is very similar. In the case of the U.S., the Fed could wait until early next year.”

Rates in the BRICs, by contrast, will continue to rise, Behravesh adds.

“On the fiscal front, certainly stronger growth will help balance some of the budgets,” but Europe in particular is taking on major fiscal austerity programs, in contrast to Japan and the U.S., “which is going in the opposite direction.”

“So among developed countries Europe is making much more progress on the fiscal front than the U.S. or Japan.”

Behravesh suggests commodity prices will rise gradually, but in the developed world “inflation won’t be a problem.” It could, however, become a problem for developing economies, “a consequence of this two-speed world.”

Finally, “the U.S. dollar will continue to decline against most currencies, with the possible exception of the euro. And of course this depends a lot on what happens vis-à-vis the sovereign debt issue.”

Mapping Probabilities

Jan Randolph, IHS Global Insight’s director of sovereign risk, suggests “the Eurozone sovereign debt crisis is probably the biggest single factor of risk aversion for investors around the world—certainly last year and probably this year as well.”

“We moved from a credit crunch to a recession into a sovereign debt crisis. Sovereign balance sheets are stressed everywhere and the Europeans have decided this is something that has to be dealt with now rather than later, and I think everyone seems to agree there’s a need for medium-term fiscal consolidation everywhere.”

“Particularly on the fringes of Europe,” Randolph adds, “the growth outlook is so weak that debt and refinancing have become a big problem.”

Randolph offers a series of probability estimates for four scenarios: the complete disappearance of the euro; the splintering off of at least one Eurozone fringe member; a multiple fracture scenario, where several nations break away; and finally what he refers to as the “positive scenario,” where member nations address their credit risks and none break away.

Randolph suggests the disappearance of the euro is highly unlikely—a probability of 1-2% in the next year, and 2-3% within five years. Only widespread and sustained political unrest, along with bond yields getting stuck in the range of 7-8% or higher could trigger this outcome, in his assessment.

Even in a worst-case scenario, Randolph says, the hard core of the Eurozone—Germany and “likeminded and like-circumstanced countries intimately linked with Germany, like Holland, Denmark, large parts of Scandinavia, Austria, Luxembourg, and possibly also Belgium—is likely to remain” on the euro, “simply because the German political class has said, this is our currency now, we’ll do everything to defend it, and it’s up to others to leave, not for us to leave.”

Almost as unlikely as the disappearance of the euro is the multiple fracture scenario, which in Randolph’s account carries a probability of less than 5% in the next year and about 5% within the next 5 years.

Especially noteworthy among Randolph’s projections is his assessment of the likelihood that a single fringe nation might break away. There’s about a 20% chance this happens within the next five years, with Greece as the most likely candidate, followed by Ireland.

Randolph also puts at 20% the likelihood that member states get their houses in order within 5 years, and none break off.

For this to happen, policymakers and politicians will need to draw up comprehensive solutions to “deal with their banking system and public sector debt issues.” Randolph also outlines the roles the ECB and EFSF would play in this outcome.

“The ECB has become more activist, is prepared to buy up sovereign bonds to keep yields down. It certainly has the power to do so, although it does see this as a chore, it doesn’t see it as its job to do this, and it would prefer the EFSF to do this. And what we may see in the next few months is a greater role for the European stability fund—it could well be an embryonic Eurozone IMF.”