• Emerging markets accounting for over two-thirds of global growth

TORONTO, Dec. 15, 2011 /CNW/ - The high social costs and political risks associated with very difficult fiscal decisions in the United States and Eurozone countries point to ongoing volatility in currency, equity and bond markets, according to Scotiabank Chief Economist Warren Jestin, co-author of a comprehensive forecast unveiled today at Scotiabank's 2012-13 Economic and Market Outlook Conference in Toronto.

Equity Trading Director Fred Ketchen moderated presentations by key Scotiabank market and economic experts, including Mr. Jestin, Alan Clarke, UK and Eurozone Economist, Camilla Sutton, Chief Currency Strategist, and Vincent Delisle, Director of Portfolio Strategy.

"Financial markets have been buffeted in recent months by heightened investor anxiety over prospects for global growth, the sovereign debt crisis in Europe and the limited progress in bringing Washington's massive fiscal deficit under control," said Mr. Jestin. "For debt- and deficit-heavy nations, the magnitude of the structural adjustments required for meaningful fiscal repair will dampen growth through mid-decade. While some European nations will eke out gains, overall growth in 2012 will be non-existent in the Eurozone as public sector retrenchment and private deleveraging push a number of distressed economies into - or deeper into - recession."

Highlights of Mr. Jestin's presentation include:

• Output growth in 2012 will struggle to reach two per cent in the U.S., even if interest rates remain near historic lows and fiscal retrenchment is postponed, which seems very likely given the high levels of unemployment, fragility of the housing sector and financial difficulties confronting state and local governments;
  
  
• Economic momentum also has moderated in many emerging nations, though growth in 2012 should be close to nine per cent in China, eight per cent in India and four per cent in Brazil.  With the traditional developed nations stuck in the slow lane, emerging markets are accounting for over two-thirds of global growth and will likely continue to do so through the balance of the decade; and
  
  
• Overall Canadian growth is likely to be similar to the U.S. in 2012, falling short of two per cent.  Domestic demand will be supported by resource sector mega-projects and public infrastructural investment.  However, household spending gains will be dampened by a moderation in job creation and greater caution in taking on additional consumer debt, now at record levels relative to disposable income.

"Output in the Eurozone is already shrinking - the only question is how severe the contraction is and how long it lasts," said Mr. Clarke. "Perversely, the good news is that things have got so bad, there is a strong chance that something good comes of it. We are reaching a crescendo. The authorities are running out of second chances and there are now two choices; the authorities pull out all the stops and help to turn the page on a deeply unpleasant episode, or hold back and watch the Eurozone tear itself apart. There are three scenarios.

• Best case scenario: Governments agree on steps towards greater fiscal union, supervision, automatic sanctions and perhaps eventually E-bonds. This is sufficient to placate the ECB that it is not giving anyone a free ride. If decisive action by the ECB and European governments can restore market confidence, it could become self-reinforcing - boosting business and consumer sentiment and restarting the recovery.
  
  
• Best worst-case scenario: Significant contagion from the periphery to the core as European leaders fail to restore confidence. This would involve a sharp tightening in monetary conditions in bigger nations as equity markets plunge, a significant bear flattening in the yield curve occurs and BOR-OIS spreads explode.
  
  
• Worst case scenario: When we run scenarios for the EUR exchange rate, equities and bond yields according to a messy Eurozone breakup, it points to PMI readings in the 20s and GDP contracting by around four per cent quarter over quarter. This should be avoided at all costs, the authorities know this and we think they will do everything possible to do so.

With respect to the currency outlook, Ms. Sutton noted, "It is an understatement that these are challenging times, and the risks to our outlook are significant. A hard landing in China, a significant deterioration in the outlook for Europe or disappointing U.S. growth would cause us to re-evaluate our forecasts. As we look out to 2012, we expect CAD, GBP, AUD, and NOK to outperform, as EUR and JPY trend lower."

Highlights of Ms. Sutton's presentation include:

• The outlook for EUR has materially softened over the last quarter of 2011 and we expect the currency to trend lower in 2012, closing the year at 1.25. Accordingly, in what is an atypical pattern, we expect EUR to trend lower against the USD, but for the USD to be weak against most of the non-EUR currencies;
  
  
• The current environment of high uncertainty, low growth and major global imbalances lays a difficult backdrop for foreign exchange markets. Most valuation tools suggest that currencies are overvalued for the fundamental landscape; however it is impossible for all currencies to weaken together. On a relative basis, we expect the non-EUR, triple-A rated sovereigns to outperform and accordingly hold bullish forecasts on CAD, AUD, GBP, NOK and SGD; and
  
  
• The environment for Canada is challenging and the risks are significant. The current risk environment is following the path it took in 2010, not the path it followed in 2008. This is encouraging for the near-term CAD outlook, as the currency is highly correlated with risk aversion. The 2010 experience suggests that CAD could weaken further, but is unlikely to enter the volatile period it entered in late 2008.

Mr. Delisle provided his view on markets. "World GDP growth is slated to hit 4.0 per cent in 2011 and is at risk of slowing towards the 3.5-3.8 per cent range next year. In our opinion, markets are currently pricing much weaker year-ahead growth. Negative revisions to 2012 profits could support further bond outperformance early in 2012 and China slowdown fears could sustain macro uncertainty. Ultimately, 2012 market leadership will be dictated by the extent of the pending slowdown, the degree of landing in China, and the 2013 recovery."

Highlights of Mr. Delisle's presentation include:

• Canadian equities have been hit by the perfect storm in recent months, as fears of a Chinese slowdown add to a challenging global debt outlook. Cyclical markets such as the TSX and the MSCI LatAm tend to hurt in periods of Chinese tightening. With the lagged effects of China's two-year tightening cycle likely visible for another three to six months, TSX headwinds could prevail heading into 2012;
  
  
• Based on the latest manufacturing surveys (PMI and ISM indices), momentum heading into 2012 is negative in China (PMI at 49), Brazil (49), Japan (49), and Europe (46) and positive in the United States (53), Canada (57), and Mexico (53). World GDP growth should be weakest in the first half of 2012 with year-ahead expectations improving in the latter part of the year. Global monetary policy is shifting back into easing and more accommodative measures should help revive growth in the second half of 2012; and
  
  
• Synchronized easing and positive U.S. payroll momentum could prove equity supportive in the near term, but we are not getting the signal to go high beta/cyclical yet. Our tactical indicators are currently pointing to a neutral cyclical tilt, which is reflected in our recommended asset mix and sector strategy.

A replay of the conference call is available until January 13, 2012 by calling 1-800-408-3053 (local: 905-694-9451) and entering passcode 5227876. A copy of the report and presentation can be found on the Scotia Economics page at www.scotiabank.com.

Scotiabank economists and market strategists are located in Canada, the United States, Mexico, Peru, Chile, Thailand, Hong Kong, the United Kingdom and France. The team provides in-depth commentary regarding the factors shaping the outlook for the global economy, currencies, capital markets and commodities as well as coverage of monetary and public policy issues.

Scotiabank is one of North America's premier financial institutions and Canada's most international bank. With more than 75,000 employees, Scotiabank Group and its affiliates serve some 19 million customers in more than 55 countries around the world. Scotiabank offers a broad range of products and services including personal, commercial, corporate and investment banking. With assets above $575 billion (as at October 31, 2011), Scotiabank trades on the Toronto (BNS) and New York Exchanges (BNS). For more information please visit www.scotiabank.com.