Factors Driving Markets

Each month, the MFS Investment Management research team analyzes the most significant factors driving markets worldwide and summarizes its findings in MFS® Global Perspective. Below are excerpts from the current issue, dated January 2007.

Global Overview

In 2007, central banks around the world will be trying to find that delicate balance between growth and inflation. We believe the U.S. Federal Reserve Board achieved that state of equilibrium in 2006 and then opted to stop raising interest rates midway through the year. Its challenge in 2007 will be to keep these competing forces aligned.

At the beginning of 2007 the U.S. economy appeared to be stronger than expected, which, we believe, bodes well for global growth. At least some of the fortunes of the U.S. and global economies will hinge on developments in the U.S. housing market. That being said, we believe world economies will grow at a robust pace in 2007 as long-awaited domestic demand takes hold in the eurozone, Japan, and in many emerging markets.

The Thai currency crisis in December underlined just how stable emerging market economies have become over the past decade. This panic, which 10 years ago would have become a pan-emerging market contagion, remained localized in Thailand. This muted reaction is a testament to the strength of the reforms that have been advanced during the past decade and which we expect will position emerging markets as leading contributors to world growth in years to come.

United States

The U.S. economy was surprisingly strong in the fourth quarter of 2006, despite the substantial weakening of the housing market. We expect the economy to remain strong through 2007 as companies continue to hire new workers and real wage increases enable consumers, who remain the linchpin of economic growth, to continue to spend.

As we begin the year, the U.S. Federal Reserve Board, like many central banks around the world, is faced with maintaining a balance between inflation and growth. At this time, we believe the Fed is using the right formula to obtain this equilibrium. However, it is difficult to predict whether the Fed will have to raise rates further. The U.S. housing market is still a risk factor, and it has detracted significantly from gross domestic product (GDP). At this time, however, we have seen very few signs that the slowing in housing is spilling into other parts of the economy. The most recent employment numbers have been strong, a sign new consumers are being added to the economy. For existing workers, wages are up, hours worked are higher, and the unemployment rate is down.

At its December meeting, the Fed said it expected 2007 growth to be slightly below the long-term trend. The central bank maintained, however, that its chief concern was still inflation and that it did not see evidence that inflation was decelerating.

We believe the Fed will keep rates unchanged for the foreseeable future. In our analysis, inflationary pressures have waned considerably, especially with respect to energy and commodities. These pressures do, however, remain a moderate threat as wages, which factor into price increases, continue to rise. The balance the Fed has achieved between growth and inflation has given it the room to keep interest rates steady.

We expect economic growth to remain between 2.0% and 2.5% in the first half of the year. We should see U.S. GDP growth pick up in the second half of the year to about 3.0%. We believe corporate earnings will grow at a solid pace, albeit at a pace slower than that seen in 2006, and support growth. As the year progresses, we will be watching corporations to see how they spend the record levels of free cash they have on their balance sheets.

Eurozone

The eurozone economy remained in recovery mode with growth strong but moderating in December and early January. The economy of the 12-country region has been growing above 2% on a year-on-year basis since the first quarter of 2006. Employment and business investment remained robust, and domestic demand continued to pick up. Unemployment fell to 7.6% in November, its lowest level since data collection began in 1993.

Despite the tighter labor markets, wage growth was still subdued, having slowed to 2.2% in the third quarter, from 2.6% in the second and 2.8% in the first. In our view, this slowing is likely to temper any major gains in consumer spending. It also will remove some inflationary pressures from the economy. With wage growth moderate, inflation was contained in the fourth quarter, allowing the European Central Bank (ECB) to keep rates on hold. The bank, which kept rates unchanged at its January meeting, raised its key lending rate to 3.5% on December 7.

Consumer and business sentiment and spending remained volatile amid the uncertainty of the global and regional growth outlook. Consumer sentiment in the eurozone fell slightly in December, while consumer spending in France beat expectations. In Germany, the Ifo survey of business confidence hit an all-time high in December. We believe the strength of this survey in Germany, which is the eurozone's largest economy, suggests that firms are clearly becoming more confident that activity will remain robust in 2007.

(The opinions expressed in MFS® Global Perspective are those of MFS Investment Management® and are current only through November 15, 2006. These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.)