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We expect imbalances to weigh on the US economy, leading to a moderate slowdown in the next two years. We see the component of domestic demand favouring the acceleration of EMU GDP in 2005E.
The Fed is likely to continue its tightening cycle with moderation in 2005. We forecast Fed rates at 2.75% by year-end 2005E. With inflation above its 2% reference target and final demand gaining momentum, the ECB should raise its reference rate by 50bp in 2005E.
The EUR/USD is expected to fluctuate in the 1.30-1.35 trading range in 2005. The outlook is blurred by the Chinese Yuan revaluation risk that would take some pressure off the currencies, which have so far sustained the burden of the USD weakness. In that case, the EUR/USD could drop to 1.25 by YE05E.
The current account disequilibria, the demand gap in some leading economies, the financial imbalances, and the commodity prices trend pose the main threats to our 2005E base-case scenario. In our assessment of risk, the slower growth and lower rates and yields mix is a higher probability than that of stronger growth and higher rates.
In our global portfolio, we are underweight on US equities, slightly overweight on EMU equities, neutral on bonds, and overweight on money market instruments. In our bond portfolio, we prefer 2Y maturities in EMU. In the US, we like 3Y in the short term and 5Y-10Y maturities in the medium term. In our euro-area equity portfolio, we overweight some value plays like Industrial G&S and Telecom, Bank and Insurance. We underweight commodity-sensitive sectors and Technology.
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