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Rothschild Expects Economies To Muddle Through 2014

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Rothschild Wealth Management has released a snapshot of what it expects to see over the next few years, but instead of making specific forecasts, the company has provided a number of different scenarios that it thinks will help investors make sense of the broad trends shaping markets.

Muddling through the recovery

Since the exercise is a high level look at the economy anyway, Rothschild is breaking everything down into two factors: growth and inflation.

“While narrowing in on just growth and inflation involves some simplification it is still worthwhile,” the company writes. “Most other economic variables and policy actions can be covered in relation to their impact on growth and inflation.”

Rothschild’s base case, Muddling Through, has monetary policy remaining very loose for the next few years and gradual or completely stalled financial restructuring by governments that doesn’t make much headway on debt reduction. Eurozone crises continue to crop up, but don’t quite get out of hand, and real interest rates are negative in most Western markets. This assumes that there are no major shocks to the system, but also no major breakthroughs in policy.

Rothschild worries about a new world order

The bear case is clear to everyone: with China struggling to prevent a hard landing and recoveries in the US and Europe still shaky, it wouldn’t take much to push the globe back into recession. Rothschild thinks that a Eurozone crisis is the most likely culprit, followed by problems in China, but doesn’t think that either is likely.

The company is more worried about what it calls a New Monetary World, where central banks raise inflation targets and increase stimulus in attempt to drive growth. “Over the short to medium term, economic activity picks up. But the impact on potential growth in the long term is negative,” the company writes.

This is similar to existing concerns that QE has already damaged long-term growth in the US even as it stabilized the economy in the short term, but with the possibility that central bankers could be accustomed to the new high liquidity environment and opt to find new tools instead of draining liquidity from the market. While tapering is expected to continue as planned this month, an economic setback in the US could halt the process in its track and actual policy tightening won’t realistically happen this year.

Rothschild recommends equities, corporate bonds

Like almost everyone else, Rothschild is bullish on equities, but they also recommend shorter-maturity corporate bonds because “there is still a decent yield advantage relative to government bonds,” the company writes. Also, “the short maturity would offer some protection against rising interest rates.”

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