Research Dept. News
|
|
|
|
Monthly Report, num 304 - July 2007
|
|
|
Overall summary - World economy: mysteries revealed?
|
|
|
|
|
|
Inverted US interest rate curve is a conundrum...
|
|
At the beginning of 2005, during an appearance before the monetary committee of the US Congress, Alan Greenspan made the word conundrum quite famous when he referred to the situation in the bond markets. Interest rates on US bonds are remaining flat at very low levels. The then- chairman of the Federal Reserve (the US central bank) was at a loss to explain why bond yields were not reacting with an upward move, as they had always done, in a stage of economic recovery, an increase in corporate profits, a rise on the stock market and an increase in employment. A later increase in the Fed’s reference rate inverted the curve, a situation that often is a prelude to recession. But there was no recession in sight. The key to the conundrum could lie in low inflation, the effects of globalization, excessive world savings, decreased risk aversion, excessive production capacity, etc. None of these factors, however, could provide a fully satisfactory explanation. Then suddenly, between the middle of May and mid-June 2007, the inversion of the interest rate curve was no more. What happened?
|
|
...but curve has normalized in recent weeks thanks to improved growth prospects, limited impact of real estate crisis and strength of private consumption.
|
|
First of all, following a very poor first quarter, US growth prospects for the second quarter are considerably better. A month before having the first official estimates at hand, forecasts by most analysts indicate a quarter-on-quarter rate raised to annual of 2.5% as against a increase of 0.6% in the first three months. The worst therefore is over. Secondly, the housing recession is not passing through to the consumer. Figures from the real estate sector show a notable impact but they are not getting worse. Prices have dropped but not very much so that the much-feared turnaround of the «wealth effect» (the price of my house has dropped, I have lost property value, therefore I must cut my consumption spending) does not have to happen. Thirdly, and the most important, the consumer is not losing spirit. In spite of everything, the indicators show a confident consumer whom not even the high price of petrol is going to dissuade from driving to the shopping centre to spend his/her last cent.
|
|
|
|
These are figures very much related to the current situation but the markets reacted with a sharp rise in long-term rates. Some large investors who were counting on a cut in interest rates by the Fed threw in the towel and went over to those who believe that the next move will be a rise in official interest rates. Interest rates on 10-year bonds rose to 5.25% on June 12, the highest level since May 2002. The return to growth, some increases in the labour market, a lower gain in productivity and the rise in raw materials prices are factors suggesting some return to the classical cycle.
|
|
Confidence in US economy returning but hardly enough not to warrant some degree of caution.
|
|
But the conundrum has not been solved by a long shot. Long-term interest rates have not kept rising following the high mentioned but rather they have dropped somewhat. And it is not too much to recall the swings the markets often hand out when it comes to trying to guess the future. The latest figures on the housing and mortgage markets show that the end of the recession is still far off and, until then, the risk of a pass-through to the consumer still remains. The US economy is still flexible and dynamic and should be capable of digesting the real estate upset. But in coming quarters the growth figures will continue to be dragged down by the weight of the real estate situation while other sectors will move ahead in the new scenario with some prudence.
|
|
While developed economies somewhat ease off growth, emerging economies do not stop.
|
|
But there is no problem. At this time, the big support of the developed economies comes from the emerging country economies. China is not faltering. Its industrial production and its exports are moving ahead at an overwhelming rate and make it possible to keep accumulating reserves, one of the major sources of global liquidity. In India, the gross domestic product grew by more than 9% in the first quarter and other emerging economies are following similar paths. So far this year, while industrial production in the developed countries has slowed down, that in the emerging countries continues full-steam-ahead.
|
|
Japan’s recovery not being confirmed and interest rates still kept very low...
|
|
In fact, Japan and the Euro Area have recently shown signs of lower growth rates. It is nothing to be alarmed at. In Japan, the economy continues to grow above potential, thanks to investment and exports. The fact is consumers are active and the much-feared deflation has not gone away. For this reason the central bank does not dare to raise interest rates that are encouraging the carry trade (borrowing yen at the interbank rate of 0.6% to invest in US bonds at more than 5% or to finance speculative funds at even higher rates). Another producer of global liquidity thus continues to operate at full speed.
|
|
...while in Euro Area prospects remain bright and ECB maintains policy of interest rate increases.
|
|
In the Euro Area, the economy continues full-ahead. Economists at the European Central Bank (ECB) are lined up with private analysts in suggesting growth of around 2.6% in 2007 and a few decimals less in 2008. According to Eurostat, in the first three months of the year the economy grew by 3.0% compared with the same period the year before. The most notable figure in the quarterly accounts was the rise in investment which went up to 7.2% year-on-year, the highest figure recorded since this European body began to publish this statistic, not equalled since the beginning of 1998. The figure for unemployment also reached lowest yet published levels, going to 7.1% of the labour force in April.
|
|
|
|
The latest figures for the situation in the 13-member Euro Area grouping show some slowing down of industrial production in April. This was a correction that may even be positive if we keep in mind the high level of utilization of production capacity (at the highest level in the past 16 years) and the risks this poses for price stability. It is not that inflationary pressures can be noted but the ECB forecasts indicate year-on-year rates in the consumer price index close to 2%, that is to say, at the limit the Frankfurt-based body considers allowable. As a precaution, at the beginning of June the Governing Council of the ECB decided to raise the reference rate by 25 basis points putting it at 4%. Jean-Claude Trichet continues to be concerned about the risks on inflation (prices for oil and other raw materials, increase in credit, wage demands) so that the increase in rates is not going to stay where it is now.
|
|
|
You can susbcribe now to be nofified by email every time the Monthly Report is updated in the internet.
|
All documents are in Adobe Acrobat format (PDF).
To view a document in PDF format you need the Adobe Acrobat Reader. If you don’t have it already loaded on your computer, you can donwload it now.
|
|
Direct link to the Research Dept. in your mobile
We'll send you a free SMS with the link
|
