Central Bank Exit Strategy Jitters     

• Private sector economists, the OECD, IMF and World Bank continue to revise upward their growth forecasts for 2010 and 2011. Ironically, however, the better the economic news, the greater the risk of an interim correction, as global equity and commodity markets shift gears from being driven by extraordinary excess liquidity to being driven by GDP and corporate profit growth.
• Since China was among the earliest with substantial stimulus that has not only re-ignited GDP growth but has also sowed the seeds of potentially damaging credit, property market and stock market bubbles, it should be the first to transition from excess liquidity. Other central banks particularly in emerging markets and Asia, will be watching how this unfolds closely, because they are the next in line to attempt the same shifting of monetary policy gears.
• While it is increasingly clear that the worst of the global financial crisis and deep recession is over, the next six months could be a delicate time for financial markets, depending on how successful central bankers in these countries manage the transition, and threats of stricter US bank regulation will add further confusion. 
• Conversely, the developed economies Europe in particular are further behind on the monetary policy transition curve.  That said, PIMCO's view of "the new normal" is looking increasingly less likely, thus the confidence in global equities over bonds despite the high perceived risk of sovereign defaults in Greece, Argentina, Russia, Ireland, Portugal, Italy, Spain and Mexico in that order.
• Meanwhile, Japan is still trying to find the accelerator i.e., monetary and fiscal policy is still in a double dip prevention mode.  This is setting up JPY to resume its role as the source currency for the global carry trade, which could push JPY to JPY100~JPY110/USD over the next 12 months. As our scenario for better relative performance from Japan in 2010 is essentially a forex call, i.e., this dynamic is good news for Japanese equities despite the fact that Japanese equities would also see short-term weakness during any meaningful interim correction in global equities and commodities.

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