Global industry will continue to slow during the remainder
of the year
but this will not be a serious slump
The US construction sector is in recession
but falling gasoline prices mean consumer demand will
accelerate regardless
In Europe the recovery faces headwinds
but not enough to stop the expansion
In Asia the economy is still cruising
and neither Japan nor China will slow down significantly
Further monetary policy tightening is on the cards
in the USA, Europe, and Japan
Introduction: The downturn is overbought
There are two layers to our global economic view in this
issue of Global Scenarios:
In the short run we repeat our call from Global Scenarios,
June 2006, that slowing industrial indicators and weak US housing market
dynamics will create increasing fears of a US-driven global downturn in the
financial markets in 2007.
In the long run, however, we do not expect this slowdown to
materialise. On the contrary, low real interest rates continuing, a soft
landing for US house prices and renewed risk seeking in financial markets after
the Fed has gone on hold will provide support for the global expansion to continue
in 2007.
Combined with a rise in US core inflation to levels
substantially above the "comfort zone", the continuing expansion will
cause the Fed to restart the monetary tightening cycle around New Year. The Fed
funds rate will be heading for 6 % in 12 months' time.
The ECB on the other hand is likely to pause by early 2007
with the refi rate at 3.5 %. The fundamental need for monetary tightening in
Europe appears less clear than in the US, and the ECB reacts with a lag to the
swings in the global industrial cycle. Renewed momentum in global growth and a
broad-based internal recovery is, however, likely to lead to even higher
monetary policy rates in Europe later in 2007.
As US monetary policy becomes tight by late 2007, a more
serious downturn in both the US and the rest of the world could be on the cards
for 2008.
Down and up on Wall Street
The mood goes "down" with the industrial cycle...
Basically our message in this issue of Global Scenarios has
two parts. The first is the "market" or "short term" part.
The second is "the real economy" or "long term" part.
In the previous edition of Global Scenarios from June, we
argued that global macro conditions would take a turn for the worse in the
autumn. Moreover, we argued that this would pave the way for a bleaker macro
view being priced into financial markets. An indeed this has happened lately,
as bond yields have started falling and a more negative growth scenario has
appeared in the pricing of monetary policy in the US, Euroland and Japan for
2007.
The increasingly negative sentiment was foreseeable given
the clear indications that global industrial indicators were beginning to
falter (see Research Global: Business Confidence Heading Down, from May 30
2006). And there is probably still more bad news in store. The deterioration of
global industrial indicators has just begun - and it is likely to continue for
the next 3-6 months. Sentiment on the US housing sector could also turn even
more sour in the months ahead as the correction in residential construction
activity unfolds.
This is the "short term" story. It is a simple and
very appealing one of a global slowdown triggered by the tightening of monetary
policy and the bursting of the US housing bubble. It is a story that is easy to
sell - and easy to buy.
But will it have been the "right" story when we
look back a year from now?
...but the global expansion is not in danger yet
We have issued 3 reports in recent weeks on the US housing
market, the US consumer and on US inflation. Our conclusions are that US
consumer spending might hold up much better than the market currently
anticipates. The purported housing crash is more likely in reality to be a
cooling (when looking at prices), and housing is actually likely to surprise
going into 2007 - house prices are not going to drop, they will merely slow.
Moreover, as we demonstrate in the USA section, the important driver for US
consumption for the remainder of 2006 is as likely to be falling gasoline
prices as housing. The drop in gasoline prices over the past month - should it prove
sustainable - will give a lift to US real incomes of around 1½ percentage
points. This kind of boost to real consumer income has consistently led to
shortterm boosts to consumer spending.
If this indeed proves to be the case, global industrial
indicators should form a bottom in late 2006/early 2007, and no major economic
slowdown will emerge. Globally, monetary policy is still way too easy and
growth momentum too strong for a major slowdown to emerge.
Moreover, US core inflation will go above 3 % and stay there
throughout 2007. The combination of close to trend growth and rising core
inflation is a recipe for further Fed hikes in H1 2007, we believe. We continue
to see the fed funds rate at 6 % in 12 months.
In Euroland, the slowing industrial indicators do not bode
well for sentiment in the short run. However, here too, there is not likely to
be any real slump in the underlying cycle. The pace of the underlying domestic
expansion in Europe was never as strong as the industrial indicators indicated
over the summer. Neither will the pace be as weak as the indicators will
suggest during the winter. Europe is fundamentally still a story of a slow
recovery after a long slump.
The ECB seems very intensely focused on using the recovery
and the energy-price-driven above-2 % inflation to neutralise monetary policy.
Some would say that they are exploiting the excuses most readily at hand. The
underlying slow fundamental recovery and the still considerable slack in the
economy do not seem to warrant as much monetary tightening as the ECB appears
to be heading for.
Looking forward, the above excuses are likely to lose
credibility - at least this will be the case for the strength of industrial
indicators over the autumn. As for inflation, a less bullish energy market
could also take inflation somewhat lower.
As European industrial indicators deteriorate the market and
the public will increasingly question the need for more European rate hikes
(see Euroland section). We think the ECB will go on hold in early 2007. But if
the US economy appears to be expanding strongly again by then there is clearly
a risk that the ECB will continue hiking into 2007.
As for Asia, this region will also feel the impact of
slowing global industry over the autumn. We have already seen some tentative
signs of weakness unfolding in Japanese data. In China, the authorities have
already taken several steps to cool the economy. Combined with slowing
industrial momentum, this will imply some deterioration of sentiment there too.
However, both Japan and China are unlikely to face any real threat to the
longer term strength of their expansions.
0 comments :
Post a Comment