Duncan’s Economic Blog

Is Deutsche Bank trying to tell Osborne Something?

Posted in Uncategorized by duncanseconomicblog on December 3, 2009

Alphaville is reporting the first few ‘2010 Outlook’ notes coming out of the major investment banks. So far we have Morgan Stanley, Deutsche and Goldman’s.  No economic forecast will ever be completely right, but it’s always worth reading these notes to get some idea of where ‘financial’ opionion stands.

Deutsche have four scenarios. The fourth one (emphasis mine) is perhaps most interesting.

  • Scenario 1 — This scenario is the most optimistic and is one where the authorities have as good a year as they did in 2009. They likely keep stimulus extremely high in the system without there being any noticeable consequences of their actions (e.g. rates at the short and long-end stay low). Under this scenario we would expect equities to be significantly higher, credit spreads be much tighter but with bond yields only edging slightly higher as the authorities are seen to have firm control of inflation expectations and may even be continuing to buy bonds.
  • Scenario 2 – This scenario is the most likely and suggests that we start to see gradual easing off the gas from the authorities but only as it’s proved that there is some momentum in the underlying economy. Under this scenario risk assets have a good year but returns are checked to some degree by rising bond yields and less stimulus being injected into markets. A satisfactory year for risk, especially equities, but a mildly negative one for fixed income. Credit investors will likely have to rely on spreads (and higher beta credit) to get positive total returns.
  • Scenario 3 – This is the second most likely scenario overall in 2010 but one that potentially becomes more likely as the year progresses. Here we are likely to see sharply higher bond yields start to disrupt the positive momentum in markets. These higher yields could be either due to Government supply starting to overwhelm demand (especially as the impact of QE, and similar schemes, wane), or because of inflation fears. It seems unlikely that actual inflation will be a concern in 2010 but it’s quite possible for expectations to become unanchored. We would also have to include the potential for a Sovereign crisis somewhere in the Developed world within this scenario. We would note that the higher yields in this scenario are not based on positive growth momentum but by inflation/Sovereign risk. Such a scenario is incorporated in Scenario 2.
  • Scenario 4 — This is the nightmare scenario of Deflation or in less extreme terms perhaps a double-dip. Given that much of the world is currently still in negative YoY inflation territory it is difficult to completely rule out even if we do live in a fiat currency system and even if inflation is expected to return to positive territory in early 2010. For deflation to be sustained we would probably need an exogenous event to hamper the authorities ability to continue to successfully fight this credit crisis. Such events could be a fresh banking crisis arising, a political backlash encouraging immediate withdrawal of stimulus, or possibly a Government bond/currency sell-off that forces the authorities to aggressively reign in stimulus for fear of a sovereign crisis. A Sovereign crisis outside the Developed world could also encourage this scenario as there would be a flight to quality into Developed market bond market in spite of the fact that these markets have their own large fiscal issues. Bond yields would eventually rally strongly but risk assets would experience a very poor year. As time progresses this scenario becomes less likely as the system gradually repairs itself and the authorities are allowed more time to inflate the global economy. As we discuss in scenario 3, the more likely risk scenario is inflation, especially as time progresses.

Deutsche think the ‘nightmare scenario’ could be caused by ‘a political backlash encouraging immediate withdrawal of stimulus’. That would be ideologically driven cuts then?

They also provide a very interesting chart which puts to bed the Tory myth of a ‘government debt crisis’. Notice how small government debt actually is…


8 Responses

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  1. Paul said, on December 3, 2009 at 12:35 pm

    Great you read this stuff . Well done.

  2. tim f said, on December 3, 2009 at 2:11 pm

    I’m probably overlooking the obvious, but what do “Fins” and “Non-fins” refer to in this context?

    • duncanseconomicblog said, on December 3, 2009 at 2:18 pm

      Sorry: Financial companies (including banks) and non-financial companies.

      Pretty clear that ‘debt crisis’ is the responsbility of the ‘fins’.

      • tim f said, on December 3, 2009 at 2:24 pm

        Thanks. That’s what I guessed, but wasn’t sure. Excellent posts today.

  3. Thomas said, on December 4, 2009 at 8:47 am

    Hi Duncan,

    The chart you have used above only goes up to Q1 2009 – I notice that at the end of the chart that the government debt to GDP ratio is starting to rise sharply (as one would expect). How much do you think activity in the last 8 months will have effected that chart? Would it be a reasonably significant effect?

    • duncanseconomicblog said, on December 4, 2009 at 9:10 am


      Even if government debt does go to 100% or so by 2014 – it would still be dwarfed by ‘fins’.

      • Thomas said, on December 5, 2009 at 8:54 am


        Well I would not say ‘dwarfed’ – but I see your point now.


  4. […] Duncan wonders if Deutsch Bank are trying to tell George Osborne something. […]

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