2012

Recession, unemployment and austerity . It's unlikely to be a great year but also unlikely to be the Armageddon that many commentators are forecasting.

The key question :
Dominating the performance of all markets and all asset classes is the question of whether the Euro can survive .My view ? The effect of a breakup would be so devastating that the common currency will probably hold together for the coming year. Some of the big investment banks are talking about a 25% drop in Euroland GDP if there were to be a disorderly divorce. This seems improbable. More likely would be a steep - 3-5%- fall in output, followed by a decade of zero growth and growing social unrest as unemployment levels rise to the mid teen.

To avoid this governments will engineer a fall in the €'s value relative to most other major currencies by lowering interest rates. This will help maintain jobs, boost Euroland competitiveness , and ease the agony of disinflation as austerity measures take hold in Spain and Italy. A mishmash of ECB bank funding and IMF loans will help dull some of the economic pain in Portugal, Ireland and Greece. This combination of factors paves the way for higher, imported, inflation in France and Germany from 2013 onwards. Imperfect but at least a workable solution. Greece, which is now effectively dysfunctional at the economic level, may see a structured default and a temporary suspension from full Euroland obligations in order to keep a lid on social discontent. A full exit by Athens remains unlikely.

The major threat to this difficult scenario will come from France. The possibility that Francois Hollande, the Socialist candidate and possible victor in the May 2012 Presidential elections, will seek to water down the austerity measures could lead to a crisis in Franco-German relations . Markets would not respond well to this perceived back-tracking . The French triple A rating would certainly go and French bank shares might need government help in recapitalizing . On the downside , there's a 1 in 5 chance that things could move out of the politicians control with French ratings seriously weakened an Italian and Spanish debt refinancings becoming untenable.

The real pressure on Euro cohesion comes in 2013 when the Italian and Spanish electorates feel the full brunt of austerity with no end in sight and before the ECB printing presses are rolling at full tilt.

Bottom line . Expect the Euro to survive in 2012 but with extreme turbulence across all asset classes as the French Presidential election and its unguarded rhetoric unfold. Market volatility , particularly in the continental banking sector, may start as soon as the new trading year .

To follow later this week. The succession issues in Russia, the US, and Saudi Arabia. Why gold is weak. Oil as an insurance policy .