FINANCIAL markets do not move in response to news, as many non-investors might think, but in response to how news changes the average expectation of the future. So understanding the consensus expectation is the tricky but vital first step in determining future financial market movements.
Currently there exists a substantial difference in the global economic growth expectations of two key sets of market participants. The major banking houses that are most active in the financial markets are increasingly positive about the outlook for
economic growth from here to the end of next year. US growth expectations of over 3 per cent in 2010 among banks such as JP Morgan and Bank of America underpin their positive views of risky asset classes such as equities and commodities and so are encouraging investors to invest more in these markets.
At the other end of the spectrum are the official forecasts of the main central banks and governments. In recent weeks, the Federal Reserve, the European Central Bank and the Bank of England have all gone to great pains to point out that, in their view, although growth is about to start recovering, that recovery is likely to be slow and the risks remain heavily skewed to the downside. Their expectations are notably lower than those of the commercial banks, and the disparity between the two sets of views is much more stark than is normally seen.
Cynically it can be argued that the banks have an incentive at the current time to be optimistic – their clients in general are long of cash and short of risky assets, and so convincing them to change these positions will benefit their revenues. It is harder, however, to be cynical about the official forecasts; there does not seem to be any incentive for these forecasts to be too low. Indeed, it could be argued that stronger growth forecasts from the official bodies might boost confidence in the economy at large and actually enable a stronger recovery.
The major consequence of these low forecasts is that governments and central banks are logically forced to concede that the current very loose monetary and fiscal policies will remain in place for a considerable period of time, and that the "exit strategies" will not be needed any time soon. This is probably not a position in which they like to find themselves.
One way of reconciling these contrasting views of the central banks and the major banking houses is that the banks' economists (who are more highly paid and are required to have a much shorter-term perspective) are probably right in detecting a faster than expected recovery in the short term, extrapolating the momentum seen in the economic data over the last two months.
However, the more structurally focused and long-term perspective of the official economic forecasts reflects the authorities' concerns that the global banking system is still too fragile to tolerate a rapid withdrawal of the emergency support measures put in place over the last year.
If this analysis is right, it leaves markets looking very well placed. A combination of extremely loose policy (low interest rates and ample liquidity provision) and continued positive and better-than-expected economic momentum is the best possible mix for financial markets.
• Jeremy Beckwith is chief investment officer of wealth managers Kleinwort Benson.
