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Developments in the European Monetary Union and the United States have raised new questions about whether political systems can deliver timely solutions to medium-term fiscal imbalances. However, the authors do not believe these imbalances will derail the global recovery, lead to problematic inflation, or prevent companies from making money.

The U.S. economy lacks clear drivers of sustained growth, and there is no "quick fix" for the housing and structurally high unemployment situations. While there is much debate about what the federal government can and cannot do to change this dynamic, it is hard to see any real solution other than a gradual, often volatile recovery pattern over several years.

We continue to recommend that investors focus on high-quality general obligation and essential services municipal bonds as the core of their bond portfolios. We also continue to recommend that investors maintain shorter-than-benchmark durations in order to dampen the risks of rising interest rates.

It may be difficult for consumers to sustain current spending levels given the sticker shock of prices at the pump. Add to the mix a move higher in interest rates, cuts in unemployment benefits and other services, and a restructuring of the Social Security and Medicare/Medicaid system as we know it, and it would seem the downside risks to growth are mounting.

We expect 2011 growth will fall into the lower end of the 3.25% to 3.75% range. Pockets of economic weakness are likely to persist – in unemployment, housing and consumer confidence – but the general economic climate is far healthier than was the case a year ago. Political and geo-political issues, we believe, are the most significant threats to continued recovery.

When the Fed ceases its massive buy program in July, it will be a de facto increase in interest rates. Who is going to step in and fill the void? The conclusion of QE2 is a well known fact, but are the consequences well understood and is this the only market dynamic that will push rates higher?

The catastrophic earthquakes/tsunamis in Japan, and the uprisings in the Middle East and North Africa (MENA) understandably dominate today’s news. Japan is clearly an enormous human tragedy, as well as one with economic consequences. The events in both of these regions have created significant global uncertainty affecting everything from gasoline prices and food supply, to automobile production and power generation. These events serve to remind us that our growing global economy is heavily dependent on evermore expensive and vulnerable sources of fuel and power.

Internal conflicts in Egypt, Tunisia, Bahrain and Libya have increased political risk and negative economic costs, warranting downgrades in sovereign debt ratings and continuing negative outlooks. But political change could ultimately be positive since governments with greater legitimacy tend to be more resilient to economic and other shocks.

The change in market psychology since the 2010 elections and the passage of year-end legislation to renew the Bush administration tax cuts should continue setting a positive tone for financial markets in 2011. We expect an expanding domestic economy, coupled with continued dynamism in the developing world, to set equity markets up for continued gains.

Forecasts for the demise of the bond market have popped up repeatedly during the past two years only to be deflated by yet another bond market rally. Arguably, it is different this time. Rising rates seem close at hand, and this paper provides detail on that view. At the same time, the paper cautions against overestimating the downside risk in bonds.