Apr 28, 2014, 3:31 PM ETPanel, Conference Presentation

The Global Economy: Hoping for Momentum amid Tepid Times

The 17th annual Milken Institute Global Conference convened with a record 650 speakers across 160 sessions.
The event reached capacity, requiring strict adherence to fire marshal mandates that close doors once seats are filled, necessitating early arrival for popular panels.
The opening panel, titled "Hoping for Momentum Amidst Tepid Times," featured CEO Jim McCoggan moderating executives from CME, UBS, Apollo, Brevin Howard, and the IMF.

Growth Forecasts: The IMF projects U.S. GDP growth at 2.7% for the current year and roughly 3% for the next.
Investor Sentiment: Apollo Global Management's Joshua Harris argues 3% growth is sustainable, driven by reduced fiscal drag, a recovering housing sector, and robust energy output.
Structural Concerns: IMF Deputy Managing Director Min Zhu notes U.S. growth remains below potential, citing weak private sector investment and the need for future fiscal consolidation due to unfunded liabilities.
Recession Risks: Panelists generally disagree on recession proximity, with Harris suggesting 2–5 years of moderate growth remain, while Min Zhu warns of a "long recovery" with GDP levels only 3–4% higher than 2007.
Investment Returns: UBS CIO Alex Friedman warns that despite benign economic growth, asset returns will likely be "tepid" due to valuations inflated by years of quantitative easing (QE) and low interest rates.

Policy Shift: Central banks are diverging, with the Fed signaling tightening (tapering), while the ECB and Bank of Japan (BOJ) lean toward further easing or QE.
Impact on Markets: This divergence creates a "very different environment" for investors compared to the previous five years, driving a shift from liquidity-driven to growth-driven asset repricing.
Balance Sheet Issues: Min Zhu emphasizes that normalization involves not just interest rates, but the reduction of central bank balance sheets, which are currently at unprecedented levels (Fed at $3.8T vs. $0.7T seven years ago).
Interest Rate Trajectory:
- Terry Duffy (CME) predicts normalized rates will be lower than historical norms, settling around 2–3% for the long term, warning that zero-rate environments are detrimental to economic health.
- Joshua Harris & Alan Howard anticipate a flat yield curve with long-term treasuries hovering near 3%, as inflation pressures remain muted despite labor market tightening.
- Min Zhu cautions that the Fed may move first, creating volatility, while the ECB and BOJ remain on the easing side.
Inflation Drivers: Panelists agree U.S. inflation will be driven primarily by wage growth (labor markets) rather than commodity prices, whereas emerging markets face commodity-driven inflation risks.

Banking Sector Deleveraging: Europe faces a massive banking sector deleveraging (50–60 trillion vs. $12 trillion in the U.S.), creating significant arbitrage opportunities for investors in distressed assets, though growth remains tepid.
Regulatory Unification: Alan Howard (Brevin Howard) identifies the ECB becoming the primary regulator as a critical turning point, potentially overriding national regulators to end "ring-fencing" and unify banking rules.
Fiscal & Political Hurdles: Germany remains hesitant on a unified deposit insurance scheme due to fears of footing bills for other Eurozone nations, complicating the path to a full banking union.
Monetary Needs: Panelists argue Europe requires both banking fixes and targeted QE to restore credit growth, as the fragmented banking system currently fails to transmit monetary policy effectively to SMEs.

Growth Stabilization: IMF data shows emerging market growth stabilizing around 4.5% globally after slowing post-2011, though countries must adjust to tighter U.S. financial conditions.
Credit Boom Risks:
- China: Concerns exist regarding $1.2 trillion in secondary bank loans and opaque credit structures that could be disruptive upon unwinding.
- Brazil & Others: High consumer credit extension and current account deficits make these nations vulnerable to capital outflows.
Investor Caution: Apollo Global Management avoids lending directly to these markets due to weak creditor rights and bankruptcy processes, preferring to raise capital locally rather than lend abroad.
Capital Flow Volatility: Min Zhu estimates $407 billion of "extra" capital flowed into emerging markets via global easy money; if this "fast money" flees, deleveraging could become highly disruptive.

Russia-Ukraine Crisis: The panel views Russia as a potential destabilizer, with risks extending beyond oil prices to the possibility of Russia being dropped from global indices, causing financial contagion.
Market Pricing: While volatility metrics remain at historic lows, panelists debate whether equity markets are correctly pricing geopolitical tail risks (e.g., a 5% probability of disaster) or ignoring them entirely.
Commodity Oversupply: Commodities are viewed as being in structural oversupply due to past investment cycles, limiting their ability to drive inflation in the near term.

Regulatory Uncertainty: Lack of finalized rules (e.g., Dodd-Frank, Basel III) and inconsistent global implementation (e.g., SEC vs. European regulators) have shaken market confidence.
Retail Participation: Individual investor participation remains low, with younger generations avoiding financial services due to perceived regulatory risks and "fast money" culture.
Market Structure: 40% of U.S. equity trades in dark pools, leading to fragmentation and opacity that hinders true price discovery and retail confidence.
Enforcement: Panelists argue that restoring confidence requires cracking down on front-running and high-frequency trading abuses, not just incremental rule changes.

Policy Mix: Japan has succeeded with monetary and fiscal stimulus but faces hurdles with the third arrow: structural reform.
Fiscal Reversal: The increase in consumption taxes has partially reversed fiscal stimulus, while structural reforms remain stalled.
Key Risks: The primary risk is "stagflation"—achieving inflation without sustainable growth, which could trigger a run on Japan's massive sovereign debt.
Future Catalysts: Success depends on deep structural reforms, such as reducing corporate taxes, opening service/agricultural sectors to competition, and securing trade agreements like the TPP.
Currency Strategy: A structurally overvalued yen is identified as a key driver of Japan's deflation and deindustrialization; further BOJ easing may be required to depreciate the currency.