In a follow-up to an analysis of Morgan Stanley's hypothesis behind the euro's overvaluation, Stephen Jen highlights two opposing forces that dictate the extent of Euroland's financial home bias, in Morgan Stanley's latest Global Economic Forum:

On the one hand, Euroland’s financial ‘home bias’ should increase over time because of the enhanced liquidity and depth of the EUR capital markets. On the other hand, gradual economic and financial convergence within Euroland will eventually erode the benefits of intra-EMU diversification and force European institutional investors to allocate more assets outside the EMU. So far, the first force has dominated. But we expect the second force to eventually kick in and lead to a reduction in the EMU’s financial ‘home bias’.

Mexico’s stock market is one of the few equity markets around the globe posting a positive return since the beginning of the year, Gray Newman and Daniel Volberg point out in Morgan Stanley's latest Global Economic Forum. And Mexico’s peso broke through levels in April that it has not seen in over two years. What can explain this puzzling - welcome, but puzzling - behavior from a market so closely linked to the U.S.?

Newman and Volberg believe there are three anomalies that explain this behavior: on the real economy front, on the energy front and on the monetary policy front.

The events of mid-March probably marked a peak in the financial firestorm, according to Richard Berner and David Greenlaw, writing in Morgan Stanley's latest Global Economic Forum. Now comes the economic fallout: The mild recession is apparently underway, as output and employment have begun to contract, capital spending is under pressure, and the consumer is fading. Though downside risks still predominate, Morgan Stanley has not revised its forecast downgrade from last month. Its forecasts remain:

Measured on a Q4/Q4 basis, we now expect real growth of 0.5% in 2008 compared with 0.7% last month, and we continue to project 2.9% growth in 2009 (the new year-over-year forecasts are 1.0% and 2.0%, vs. 1.1% and 2.2% previously; compare “A Darker US Outlook”, Global Economic Forum, March 10, 2008).

Inflation in India is rising - the headline rate reached a four-and-a-half year high of 7.0% in the week ending March 22, 2008 - but Chetan Ahya and Tanvee Gupta in Morgan Stanley's latest Global Economic Forum wonder if monetary tightening is the right response.

This period of rising inflation is unlike the last period when inflation accelerated beyond the central bank's comfort zone (November 2006 to March 2007): Domestic demand and the overall growth trend have slowed down significantly and industrial production decelerated to a four-and-a-half-year low of 5.3% in January 2008. This inflationary cycle, according to Ahya and Gupta, reflects higher global commodities: base metals, fuel and food items.

Jim Sinegal in Morningstar argues in favor of banks' cutting their dividend payments, while Morningstar Dividend Investor editor Josh Peters takes the opposing stance. For the likes of Citigroup (C), Wachovia (WB) and Huntington Bancshares (HBAN), maintaining high dividend payments may simply no longer be an option, but what choice do the likes of Wells Fargo (WFC), US Bancorp (USB) and Bank of America (BAC) face?

Sinegal believes that there are preferred alternatives to paying large dividends in today's climate, including share buybacks and knock-down bargains on distressed assets.

Stephen Jen and Luca Bindelli put forward a new hypothesis to explain why the euro has been so over-valued in Morgan Stanley's latest Global Economic Forum. It is based on a European tendency to diversify within the Eurozone, while U.S. and other real money investors increasingly diversify outside their own spheres. As Jen and Bindelli explain:

Most of the rest of the world have also been reducing their financial ‘home bias’ by diversifying out of their own domestic asset markets. However, European investment funds [IFs] have diversified more within the Eurozone than outside the Eurozone, i.e., they diversified out of their own countries but into other EMU member countries, and not out of the Eurozone. The EUR, therefore, should be strong if everyone else in the world is diversifying while the Europeans are not.

The euro area has shown surprising resilience in the face of the gales sweeping through financial markets, writes Elga Bartsch in Morgan Stanley's latest Global Economic Forum. However, on the back of upward pressures on the money market and credit spreads, Morgan Stanley lowered its GDP growth forecasts for the euro area to just 1.5% for both this year and next (see Morgan Stanley's Euroland Economics: From Soft Rebalancing to Conflict of Interest, March 19, 2008). This is below market consensus, below the ECB’s staff projections and below the official forecasting community.

Bartsch elaborates:

WellPoint (WLP) won a five-star recommendation from Morningstar this week. According to Morningstar analyst Matthew Coffina, WellPoint's economic moat is founded on its scale: it is the largest U.S. health insurer, with 35 million members.

Brazil has enjoyed an exceptionally favorable economic environment in recent years, but the times they are a-changin', according to Marcelo Carvalho, writing in Morgan Stanley's latest Global Economic Forum. Though Brazil's outlook for 2008 remains firm, the global slowdown will likely impact on the economy in 2009, bringing an end to Brazil's run of better-than-expected growth figures. As Carvalho notes:

The global growth outlook is darkening. Indeed, in January, the IMF already cut its estimate for 2008 global growth by 0.3pp. And it looks bound to cut it yet again at the upcoming release of its semi-annual World Economic Outlook on April 9. Our global economics team sees global growth slowing by a full percentage point this year, from an estimate of almost 5% in 2007 to about 4% in 2008, with risks still biased to the downside. Indeed, with concerns that the US slowdown might prove to be deeper and longer than initially foreseen, it would not surprise us to see 2008 global growth figures eventually sliding towards the 3% mark. Our global team sees some recovery in 2009. But the recovery path remains short of the growth pace seen in 2007, and risks are that it could prove tepid.

Daniel Loeb's Third Point disclosed a 7.1% stake in California-based REIT Maguire Properties (MPG) in a 13D filing yesterday. According to StreetInsider.com, Loeb's firm paid approximately $76,044,482 to acquire the 3,350,000 shares. Third Point showed no stake in Maguire at the quarter ended December 31, 2007.

High oil prices could cause a temporary setback for the Indonesian economy though the impact will be more moderate than that suffered in 2005, according to Deyi Tan and Chetan Ahya, writing in Morgan Stanley's latest Global Economic Forum. In October 2005, oil prices crossing the US$65 a barrel mark led to a "mini-crisis" in Indonesia, with the government forced to raise fuel prices by 126% in October 2005 and to hike policy rate by 42bp in the second half of the year. What does the country face now with headline inflation at 7.4% and oil prices hitting beyond US$100 a barrel?

Tan and Ahya analyze the three broad areas affected by oil prices:

The growth environment has deteriorated in India recently, report Chetan Ahya and Tanvee Gupta in Morgan Stanley's latest Global Economic Forum, and consequently they have revised their GDP growth estimates down from 7.4% to 7.1% for F2009 and from 7.8% to 7.6% for F2010.

Morgan Stanley covers several factors that have led to this revision, among them, weaker consumption growth and slower export growth. Household leveraged spending is down (seen, inter alia, in two-wheeler sales), while growth in consumer goods production fell to only 4.3% in the three months to January 2008 from a peak of 18.5% in June 2005. Weakening global demand together with the rupee's appreciation led export growth to fall to 7.9% over the past six months compared with 23.3% in the year to March 2007. A looser fiscal policy may help to soften the blow, but, as Ahya and Gupta argue, some slowdown in consumption was necessary to reduce the risk of overheating:

As Northern Trust's Global Economic Research Week in Review [.pdf] shows, sales of existing homes have increased, on a year-to-year basis, due to the fall in prices. In fact records have been broken in today's housing market, and the records are of house price declines.

The median price of a single-family home was down 8.7%, the largest drop in record.

The Canadian economy is likely to experience a deeper and longer slowdown than previously thought, according to Charles St-Arnaud writing in Morgan Stanley's latest Global Economic Forum, and this is likely to impact on USD/CAD.

The latest Canadian GDP figures confirm that, while on the one hand, external demand is weak and the strong Canadian dollar is dragging the economy down, on the brighter side, the domestic economy is buoyant, this due principally to a strong labor market, increased purchasing power and strong income growth. However weaker global growth in 2008 will have repercussions for an economy where exports account for 35% of GDP. St-Arnaud sees consumer spending remaining solid, albeit moderating more than previously expected, while business investments too are likely to moderate.

With the US dollar indices at record lows, there is much concern over whether the currency will lose its reserve currency status. However, as Stephen Jen points out in Morgan Stanley's latest Global Economic Forum, when assessing the merit of the US dollar as the dominant international currency, it is important to distinguish between these three uses of international money: a store of value, an international unit of account and a medium of exchange. While Jen believes that the US dollar has maintained its status in the latter two, it has deteriorated significantly as a store of value. Does that mean, though, that its time is up?

In the long run, the most likely contender to the USD as the dominant international reserve currency, in our opinion, is likely to be an Asian currency centered on the Chinese RMB. But this risk may be several decades away, we suspect.

Alcoholic beverage companies are typically great businesses, Ann Gilpin points out in Morningstar, though the soaring prices of hops and barley will provide some tough challenges. While operational efficiencies will help, Anheuser-Busch (BUD) and Boston Beer (SAM) have both warned that the higher commodity prices will impact on their gross margins as they will not be able to raise prices high enough in 2008 to offset the extra costs.

Molson Coors (TAP) on the other hand is likely to see its gross margins expanding, Gilpin reports, as it enjoys economies of scale in the U.S. market through its joint venture with SABMiller (SBMRY). Boston Beer though will have a tougher time:

There is increasing support for the use of unconventional tools to fix the current credit crisis, writes Richard Berner in Morgan Stanley's latest Global Economic Forum, referring to the direct assistance to help struggling homeowners, dislocated markets and financial institutions. The use of such tools is clearly a case of crossing the Rubicon for policymakers, but Berner argues that such a step is justified.

Without such action, the credit crisis could take years to unravel, and the cost over time could be enormous:

In Northern Trust's latest Global Economic Research [.pdf], Paul Kasriel gives us a history lesson, recalling the sharp interest rate cuts by both the U.S. Federal Reserve and the Bank of England from late 1929 until mid-1931. There followed a run on the pound, which the Bank of England countered by sharply re-raising its rates and then abandoning the Gold Standard in September 1931. Similarly pressured, and facing a heavy gold outflow, the Fed raised its rates. Kasriel explained the need for the history lesson: so that we can understand why the Fed's current interest rate policy could similarly be "constrained by developments in the foreign exchange markets."

While there may be no run on the currency today, Kasriel does recognize a "walk on the dollar," and, in the light of other major central bankers' expressed reluctance to lower their interest rates further, continued reductions by the Fed, he suggests, would put downward pressure on the greenback.

Not all is lost in the auction-rate securities market, argues Joe Mysak in Bloomberg today. Admittedly the market has been suffering, with some 70% of auctions in the once-$330 billion market now failing, according to Bloomberg data. When auctions fail, issuers - about half of whom are states and municipalities - pay a penalty rate and the resulting interest has soared to levels far higher than alternative channels.

So the Municipal Securities Rulemaking Board, the self-regulatory organization that covers the municipal market, is attempting to salvage the situation, with plans to improve transparency and daily data collections. At minimum denominations of $25,000 (as opposed to a minimum $100,000 for variable-rate demand obligations), Mysak reports that it is not just "the rich" who buy:

Having saved for the proverbial rainy day, Chile finds itself in an enviable position, reports Luis Arcentales in Morgan Stanley's latest Global Economic Forum. Unlike others in Latin America, Chile can afford to conduct a counter-cyclical fiscal policy, despite the fact that it is heavily dependent on commodity exports and has the smallest international reserves - at 10% of GDP - of any major Latin American economy aside from Mexico.

Chile though has acted on soaring copper prices and maintained fiscal discipline, producing massive surpluses. Arcentales argues that this is sound practice from two perspectives: