Analysts from both Credit Suisse and BCA Research see the U.S. Federal Reserve Board’s action on interest rates as the key to forecasting the outlook of global markets this year.

Credit Suisse says that its analysts see decent growth in the first quarter, slowed by interest rate hikes in the second, followed by recovery in the second half of 2005. “Global economic growth has been slowing since spring 2004, reflecting higher oil prices, the fading stimulus from U.S. tax cuts, a slight cooling of the overheated Chinese economy, and the initial effects of rising central bank interest rates,” it says. “The latest data, however, indicate that this slowdown should give way to a re-acceleration during the second half of this year.”

Analysts at the Swiss bank expect the U.S. dollar to continue its rebound during the first quarter, as markets gradually price in more monetary tightening by the Federal Reserve. In the second quarter, this rebound is likely to taper off and give way to a slightly weaker dollar, although this year, the greenback is not expected to sink below the lows seen a few weeks ago, for any sustained period of time.

“The Fed is likely to be more resolute this year than previously assumed in tightening interest rates. Particularly on a 12-month horizon, the extent of the interest rate hikes that the markets have already priced in is probably insufficient, “ it says, predicting that by the end of 2005, the U.S. federal funds rate will likely reach a level of 4%.

This sort of rate hike in the U.S. Is the key threat to the global economic and investment outlook, adds Montreal’s BCA Research. “The U.S. is the backbone of global spending. The world continues to face a chronic excess supply of savings (and there are no candidates to replace a shortfall in U.S. spending. Consequently, low U.S. interest rates may be necessary to sustain global demand,” it says.

“Fed tightening threatens to undermine what appears to be a fairly stable balancing act at the moment,” BCA adds. “U.S. retail spending growth is still solid, but in the past it has slowed markedly during Fed tightening cycles. This highlights that global growth and stock prices are at risk while the Fed is hiking interest rates.”

With central banks raising interest rates and spreads at tight levels, Credit Suisse says some overall underperformance of corporate bonds compared with government papers is likely in 2005.

It is not as negative on stock markets, as long as capital market yields do not rise too much and the Federal Reserve tightens interest rates at a moderate pace. The equity strategists at Credit Suisse see scope for the bull market to continue into the first quarter of 2005 and perhaps into the early second quarter as well. “Europe and Japan offer the most upside potential,” it says. “The stock markets are likely to peak in spring 2005, and a subsequent correction could extend into the third quarter.”

Within equity markets Credit Suisse recommends purchasing stocks with already good dividends that are expected to increase payout rates this year: for example, selected European insurers. Another strategy is to overweight large caps against small caps, and growth against value stocks. In addition, they are suggesting several longer-term themes, notably those concentrating on potential Chinese global brand leaders of the future, and specialized themes such as alternative energies.