In this mid-year outlook, we have invited four of Mellon’s specialist asset managers to outline their views on what they see as pertinent drivers in financial markets. In the first article, The Boston Company Asset Management provides a macroeconomic review as well as its outlook on global markets from here. The second article provided by Mellon Capital Management considers the relative strength of equities versus bonds. The next, produced by Newton Investment Management, explains the interaction of market volatility and asset prices, while the final article from Standish Mellon Asset Management outlines a balanced approach to the boom and bust cycle of assets.

The first half of 2006 was characterised by a period of relatively benign inflation – despite high energy and commodity prices – and global economic expansion driven by buoyant US demand, robust growth in Asia and other emerging economies, and improving fundamentals in Europe and Japan.

In financial markets, however, the mood vacillated in part over concerns that inflation would be a problem and that the incoming chairman of the Federal Reserve, Ben Bernanke, would not be as tough with his tackling of inflation as his predecessor Alan Greenspan. With inflationary pressures appearing to be picking up, central banks, including the European Central Bank, raised interest rates in response. These worries were also aggravated by geopolitical tensions and high oil prices. Still, equity markets made some good progress in the first four months of the year, while bonds were left on the sideline as the expectation for future growth favoured equity markets. The announcement by the Bank of Japan of its plans to end its quantitative easing also had a

negative impact on bond markets. However in May, news of revised annualised GDP growth in the United States of 5.3% (from the initial 4.8%) and a larger-than-expected rise in US core inflation triggered a general market sell-off. This culminated in a flight to quality, from which bonds benefited for a short time before declining again on renewed inflation fears. The confusion spilled over into currency markets notably in emerging markets with the South African rand and Brazilian real depreciating against the US dollar. Today, the picture still remains unclear. Recent data is suggesting that the US economy is facing a slowdown in the housing market, but at the same time US interest rates are rising beyond previous market forecasts.

Against this challenging backdrop, four of Mellon’s specialist asset managers have provided detailed insight into the likely future direction of markets. Their differing investment focus and style have led to views, which in aggregate provide an outlook that is both diverse and compelling.