KUWAIT CITY, Sept 24: While concerns had taken a toll on financial markets in 2Q2011, those concerns turned to outright fears in 3Q2011. Stocks decidedly and decisively put recent post-Lehman highs behind them, at least for the time being. The Dow Industrials index, for example, came down over 2000 points from its recent high of 12800. Flight-to-quality propelled interest rates lower, at least on higher-quality sovereigns, US 10-year notes and German Bunds with yields at, or below, 2.0%. Gold contracts made historic highs at $1800-1900 per ounce in recent weeks.

What happened in 3Q2011? You could say: everything. Greece required a second bailout package. The US came close to defaulting with the legal debt-limit extension saga, and it saw its once pristine credit rating downgraded by S&P. The Greek debt matter extended, on and off, to Italy and Spain and saw the ECB acting reluctantly, on yet another matter: by buying Italian and Spanish debt in order to calm markets, and push rates lower (to “sustainable” levels for those debtors). Fears erupted over French and German banks in light of their exposure to Greek debt, both sovereign and private. Later, in September, Italy’s debt was downgraded and Moody’s downgraded two of France’s largest banks.

Markets’ confidence was further eroded by the perception that policy makers are still being too timid and/or that policy options are dwindling rather fast. To add insult to injury, the US economy decided to send stalling signals in terms of GDP growth and employment, thus contradicting Fed Chairman Ben Bernanke. The latter had said earlier this year that growth would improve in the second half of the year. The Fed which had stopped its QE2 program (purchase of $600 billion in US Treasury notes) in late June, was saying soon afterward in an official and an unprecedented manner that it, the FED, would keep short policy rates unchanged until at least mid-2013. Also unprecedented on a major decision, 3 out of 10 FOMC voting officials dissented. Fiscal policy is expected to provide some limited relief with President Obama’s proposed $447 billion stimulus, though we await further details and action there.

With the last revision US GDP growth was 1.0% (saar) in 2Q11, while-nonfarm payroll showed zero new jobs in August. The Fed thus hinted that, if need be, further action would be taken, such as extending the maturity of its portfolio (no outright QE3 for now). Data from the EU were similarly suggesting a slowdown, even the “core”: German GDP up 0.2% in 2Q11, France “flat”. In an eerie reminder of 2008 when the ECB tightened as we were headed for the financial crisis and the Lehman iceberg, the ECB just recently tightened twice (50 bps). However, the ECB is now expected to reverse course and start cutting rates soon. The debt concerns are ever rising and the economies are suffering as well, PMI data from the EU and individual countries are also pointing to slowing growth, and fears of a recession, at least, in the US are on the rise.

Should we avoid recession in the US/EU economies, the emerging markets should continue to exhibit decent growth (China near 9%, India 7%), enough to keep world growth near 4.0% according to consensus. The danger and risk is that weakness and/or financial turmoil unhinge world exports and business sentiment, respectively, enough to weaken world growth much further.
Inflationary expectations are receding in the now vulnerable advanced economies, and thus should give their central banks room to keep accommodative policies in place (or to ease like the ECB). All eyes are still on Greece as it awaits its assistance package, and more ominously as DEFAULT is not taboo anymore. The problem is that default, if it comes, can come in many forms and investors’ visibility at this point is beyond foggy. Orderly default is what is now sensed by the markets, with or without Eurobonds, though bear in mind that the latter and the whole apparatus will take time to introduce (changing EFSF, ratifications and new rules needed…). Also, will Greece leave the Euro zone? That much more turbulent turn of events seems to be out for the time being.
The GCC (and MENA) markets are showing signs of decent growth for the second half of this year and into 2012, barring major international disruptions. Oil prices remain well supported above 100-110 $ pb (Brent basis). These prices are well above these break-even prices for the GCC and should continue to support stimulative government spending programs. We expect real GDP growth of 5.0% for the GCC.