Investment Perspectives — Europe

US Economics US Budget Forecast Update:
The Song Remains the Same

We are updating our US budget forecast to incorporate the CBO baseline estimates released recently and some of the policy proposals outlined in President Obama’s State of the Union Address. Also, we consider the long-run budget picture. The bottom line is a slightly more pessimistic assessment of the US government’s fiscal situation over the next few years than previously thought and a dim view of the longer-run outlook.

For the current fiscal year, we expect the US budget deficit to be $1.325 trillion (or 9.1% of GDP), compared with our previous estimate of $1.25 trillion. The deficit is expected to
decline gradually over the next few years as economic recovery takes hold, tax rates rise, and stimulus-related spending slows. In 2011, our deficit estimate is $1.16 trillion (7.7% of GDP), and by 2012 we see the deficit at $930 billion (5.9% of GDP). While the declining trajectory of these
projections might seem somewhat encouraging, it should be noted that further progress beyond 2012 would be grudging at best under current policies.

Global Interest Rate Strategy
Eye of the Tiger

An unwind of market risk offers an opportunity to put more on, in our view. In the Chinese zodiac, February 2010 marks the year of the tiger and denotes a period of great change. The change we see ahead is one of a significant rise in rates and steepening of yield curves. We urge investors to look into the eye of the tiger as yields fall and position for just such a market move. The risk of tighter policies in China and other Asia-Pacific (AXJ) nations, considered to be the engines of global growth, has caused many investors to reduce risk. Sovereign risk events in Greece and the unknown variables surrounding tighter banking regulations in the US have
caused a further unwind of risk; opposite to what we saw in the last several months of 2009. While the tail risks have increased, fundamentally we do not believe that prospects for global recovery have changed. As a result, we see this unwind of risk as an opportunity to add to our core views for higher rates and steeper curves.

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