UBS analysts have published their latest report on the course of the global economy, pointing out the 5 main reasons why 2012 will be a totally different year from 2011.
According to the analysts, in the first semester of 2011, everyone expected the financial crisis to deteriorate and the bond swaps to skyrocket. Instead of this, it was the EU common currency that reached an exchange rate of 1.50 dollars compared to its 1.30 worth today.
Can this happen again in 2012? The answer is no, according to the Swiss economists, at least for Europe.
And these are the exact reasons from the UBS:
1) ECB
In early 2011, the ECB sounded hawkish and then went on to hike rates in April and July, just as the Fed prepared to embark on QE2. 2012 will arguably be very different as the ECB is likely to cut rates to a new historic low of 0.50% and might well then embark on outright QE. At a time when the Fed looks largely done with its QE efforts, this could hit EURUSD hard and for us is the single most important reason to be structurally bearish the euro in 2012.
2) Greece
There is now a non-negotiable deadline for the Greek PSI, which is the bond redemption on 20 March. Negotiations for the new troika programme continue to assume a ‘voluntary’ PSI resulting in a 50% haircut and a debt-to-GDP reduction to 120% by 2020. However, revenue shortfalls due to the deeper-than-forecast recession look set to result in additional financing needs, which in the absence of new official money might mean a larger haircut and hence a coercive restructuring.
3) Contagion
If Greece is forced to impose an involuntary restructuring on investors, the market might quickly move on to Portugal or even beyond. Eurozone leaders have frantically worked at erecting a ‘firewall’ for countries beyond Greece in case of a default occurring. So far they have had limited success apart from raising more cash for the IMF and advancing the European Stability Mechanism (ESM) to mid-2012. Still, these instruments are arguably not yet powerful enough to deal with a country like Spain or Italy loosing market access.
4) CDS
The above Greek scenario would result in a credit event being declared and credit default swaps (CDS) being triggered. Many observers might welcome such an event as a proper default would mean that Greece was finally declared ‘insolvent’ and unable to pay its obligations, which most would argue might be better for the longer term health of the system than pretending otherwise. Still, nobody knows how the financial system would handle CDS payouts of more than €80bn (gross). At least as an initial reaction, the market would probably be highly stressed.
5) Politics
The EU has an impressive track record in pushing through projects even against resistance from individual countries and with minimal explicit or implicit support from electorates. However, there may come a point where populations start to rebel, possibly when they are simultaneously faced with ever deeper cuts in public services and ever higher taxes. A relatively benign problem might be resistance to ESM ratification in some countries, but more serious social unrest could occur both in debtor as well as creditor countries.
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