The banking crisis is not over and the global economic recovery is far from guaranteed, according to Danny Gabay, a director at Fathom Consulting in London.
While a gradual recovery led by the US and Asia is still Gabay's central forecast, he said the risks are becoming far uglier and collectively more likely forcing investors to walk a tight rope.
"We see the chance of two major evils. Weak growth with inflation or even weaker growth and deflation," says Gabay.
"The biggest risk for the G4 is a repeat of Japan's lost decade, rather than inflation. We see a 40 percent chance of deflation across the entire G4 in 2011," he said.
Gabay is worried by falling money supply in the US and euro zone despite central banks attempts to pump liquidity into the system: "this money has failed to make its way into the wider economy."
Analysts at Fathom say the big risk remains a banking crisis and see the euro's big losses against the dollar as a direct result of the three-year financial crisis that has "yet to be resolved." (Click Here for Currencies Data)
"We now conclude that the risk of a sharp upward spike in bond yields across Europe, driven by fears over insolvency by a handful of euro zone members is still prominent but has receded," Gabay said. (Click Here for Bonds)
"A greater risk now is that the banking crisis continues to run ahead of governments, triggering another leg down in economic activity," Gabay said.
Financial risk cannot be canceled by "simply moving it from one balance sheet to another," Fathom Consulting analysts wrote.
The financial crisis "has ebbed and flowed" from US sub-prime bondholders in 2007 to sovereign debt today, "but it has not yet been consigned to history," they added.
For the third quarter Fathom are underweight bonds, overweight equities and cash.
"We prefer US bonds over but are negative US and Japanese stocks. We prefer EU and UK stocks," they wrote.
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