The market continues to underestimate the strength of the emerging global economic recovery as strong growth outlooks shift from Asia to Western economies, according to new research from Barclays Capital, the investment banking division of Barclays Bank. Barclays Capital (BarCap) expects to see a further upside in risky assets, while the market will grow more vulnerable to policy tightening. "We first recommended that investors re-engage in risky assets in March of this year, well ahead of the consensus," said Larry Kantor, head of research at BarCap. "We are reiterating that view now as we see a stronger global recovery than the market expects. We have raised our GDP forecast for the US and expect the unemployment rate in the US to be in a downtrend by the end of the year." Kantor added: "If our expectations prove correct, then the market will begin to look for signs of policy tightening and the current favorable window for investors will close." In the mean time, however, BarCap recommends favoring equities over corporate credit. The firm suggested investors focus on sectors that benefit from business-led recovery, including industrials and technology. Recovery strength looks ready to shift from the emerging Asia to the major developed economies including Europe, which will be led by the US economy. Downward momentum of the dollar should continue in the near-term as risk appetite improves, BarCap said. BarCap mortgage-backed securities (MBS) analysts and economists seemed less optimistic this week in terms of house prices. Despite recent positives from the Case-Shiller index, BarCap analysts indicated in a Tuesday conference call that improvements resulted from "unsustainably low" rates of housing units rolling from foreclosure to real estate-owned status. These roll rates should accelerate in coming months as seasonally strong voluntary sales fade, BarCap noted, adding this should put additional pressure on house prices. "[BarCap analysts] now expect another 8% decline in home prices as measured by Case-Shiller (the FHFA equivalent would be another 3% decline) for a total peak-to-trough decline of 36%, with the bottoming to occur in 2Q10," the firm said in a research note on the call. "While these estimates make them more bullish than most fixed income investors, we suspect this conclusion is more bearish than is priced into the equity markets, which appear to have responded to recent positive Case-Shiller readings by aggressively bidding up of stocks with exposure to mortgage credit risk such as the mortgage insurers in a way that reflects an optimism that home prices have stabilized." As distressed house supply continues to act as a "primary driver of home prices," BarCap analysts expect the correlation between foreclosures and home prices to increase once the pace of foreclosure liquidations increases even after government programs designed to slow the pace of distressed sales. Amherst Securities Group analysts also see a large overhang of 7m distressed units in the US shadow inventory of foreclosures. As these loans liquidate in months to come, Amherst expects to see recent gains in house prices to falter. Write to Diana Golobay.