Stagnation or Growth?? Either Way, Interest Rates Go Up
We are in real trouble if the US economy does not show some real growth signs (job creation and wage increases) and in particular Corporate America does not step up to the plate soon (domestic investment, capex, real jobs and wage increases). I expect a 1st quarter slowdown in corporate revenues, which will mask the real growth coming in the 2nd and 3rd qtr. The following excerpts are from Stephen Roach and Richard Berner at Morgan Stanley.
Japan and Germany -- the world’s second and third largest economies -- moved into recession territory in late 2004. Even the US experienced a marked slowdown in GDP and productivity in the 4th qtr. The Baltic Freight Index -- a good proxy for global trade -- indicates a slowdown. The yield curve is flattening, compressed by long term rates coming down and short rates going up.
Japan and Germany are indicative of the latest trend, big economies that lack the core support of self-sustaining internal demand. Lacking internal demand, any shortfalls in external demand are a problem. Three years of dollar weakness matched by sharp appreciation of the euro and the yen has exposed the externally-led recoveries in both Japan and Germany.
The interest-rate-sensitive components of the US economy -- consumer durables, homebuilding, and business capital spending -- collectively surged 8.8% in 2004; that was literally three times the 2.9% growth in the remainder of the economy and compares with average gains in these components of just 2.5% over the 2002-03 interval. Putting it another way, while these three segments made up about 25% of the level of US GDP in 2003, they accounted for about double their share, or 51%, of the overall growth of US GDP in 2004.
In China, the slowdown continues apace driven by a combination of administrative and macro policy tightenings, Chinese industrial output growth slowed from 19.4% in the first two months of 2004 to 14.4% by December -- seemingly a classic soft-landing. Excess liquidity and a Shanghai-centric property bubble underscore the risks on the downside.
Incoming data on Chinese industrial output in January is not all that comforting. In January and February, average daily output growth slowed to just 8.9% in January.
There is corroborating evidence from the Baltic shipping index. The Baltic Dry Index -- long a good proxy of the fluctuations in global trade -- so far in early 2005, the year over year % comparison has slipped back into negative territory -- the first such swing from positive to negative growth since the 2001 recession.
China is lacking in self-sustaining support from domestic demand. Its auto sector is now in the bust phase of a classic business-cycle adjustment and there are mounting downside risks to an over-extended housing sector. (Sound familiar?)
An externally-led Chinese economy also remains very much a levered play on the American consumer. Should the US consumption dynamic downshift further in 2005, the China slowdown could well breach the downside of the soft-landing threshold.
The key question is whether the late 2004 global slowdown is a portent of tougher times ahead. There are underlying manifestations of stronger global growth -- namely, rising inflation in the US, liquidity-induced speculative excesses in China, ECB rate hikes in Europe, and demand-driven upside risks to oil prices.
As such, we speak more of bond bubbles than of the possibility of a further reduction of long-term sovereign interest rates. As I see it, the key presumption of this global view is the belief that the unshakable American consumer will power yet another wave of US-centric global growth.
January’s surprising 0.8% jump in core producer prices has rekindled inflation fears. Small wonder: Such prices soared 2.7% from a year ago, or at the fastest year-over-year pace since November 1998. Is this jump just a one-time blip or the beginning of a sustained upturn in goods pricing?
And will it translate into higher overall inflation at the consumer level? Pricing power has steadily matured from infancy to adolescence in much of Corporate America over the past eighteen months, but I’d be the first to agree that this newfound muscle isn’t yet ubiquitous. Nonetheless, I think more inflation surprises are coming, and soon.
Three factors point to clear upside risks to future inflation: Dwindling economic slack, rising costs combined with slower productivity growth, and a still-accommodative monetary policy.
The FOMC “central tendency” core inflation forecasts are steady at 1½-1¾% through 2006, yet the “market-based” version of the PCE chain price index is already at the upper end of that range, and I think that inflation fundamentals point to additional upside inflation risks.
In my view, therefore, the Fed would have to tighten monetary policy significantly further to come close to turning those forecasts into reality.
See Morgan Stanley Digest: http://www.morganstanley.com/GEFdata/digests/20050222-tue.html
Japan and Germany -- the world’s second and third largest economies -- moved into recession territory in late 2004. Even the US experienced a marked slowdown in GDP and productivity in the 4th qtr. The Baltic Freight Index -- a good proxy for global trade -- indicates a slowdown. The yield curve is flattening, compressed by long term rates coming down and short rates going up.
Japan and Germany are indicative of the latest trend, big economies that lack the core support of self-sustaining internal demand. Lacking internal demand, any shortfalls in external demand are a problem. Three years of dollar weakness matched by sharp appreciation of the euro and the yen has exposed the externally-led recoveries in both Japan and Germany.
The interest-rate-sensitive components of the US economy -- consumer durables, homebuilding, and business capital spending -- collectively surged 8.8% in 2004; that was literally three times the 2.9% growth in the remainder of the economy and compares with average gains in these components of just 2.5% over the 2002-03 interval. Putting it another way, while these three segments made up about 25% of the level of US GDP in 2003, they accounted for about double their share, or 51%, of the overall growth of US GDP in 2004.
In China, the slowdown continues apace driven by a combination of administrative and macro policy tightenings, Chinese industrial output growth slowed from 19.4% in the first two months of 2004 to 14.4% by December -- seemingly a classic soft-landing. Excess liquidity and a Shanghai-centric property bubble underscore the risks on the downside.
Incoming data on Chinese industrial output in January is not all that comforting. In January and February, average daily output growth slowed to just 8.9% in January.
There is corroborating evidence from the Baltic shipping index. The Baltic Dry Index -- long a good proxy of the fluctuations in global trade -- so far in early 2005, the year over year % comparison has slipped back into negative territory -- the first such swing from positive to negative growth since the 2001 recession.
China is lacking in self-sustaining support from domestic demand. Its auto sector is now in the bust phase of a classic business-cycle adjustment and there are mounting downside risks to an over-extended housing sector. (Sound familiar?)
An externally-led Chinese economy also remains very much a levered play on the American consumer. Should the US consumption dynamic downshift further in 2005, the China slowdown could well breach the downside of the soft-landing threshold.
The key question is whether the late 2004 global slowdown is a portent of tougher times ahead. There are underlying manifestations of stronger global growth -- namely, rising inflation in the US, liquidity-induced speculative excesses in China, ECB rate hikes in Europe, and demand-driven upside risks to oil prices.
As such, we speak more of bond bubbles than of the possibility of a further reduction of long-term sovereign interest rates. As I see it, the key presumption of this global view is the belief that the unshakable American consumer will power yet another wave of US-centric global growth.
January’s surprising 0.8% jump in core producer prices has rekindled inflation fears. Small wonder: Such prices soared 2.7% from a year ago, or at the fastest year-over-year pace since November 1998. Is this jump just a one-time blip or the beginning of a sustained upturn in goods pricing?
And will it translate into higher overall inflation at the consumer level? Pricing power has steadily matured from infancy to adolescence in much of Corporate America over the past eighteen months, but I’d be the first to agree that this newfound muscle isn’t yet ubiquitous. Nonetheless, I think more inflation surprises are coming, and soon.
Three factors point to clear upside risks to future inflation: Dwindling economic slack, rising costs combined with slower productivity growth, and a still-accommodative monetary policy.
The FOMC “central tendency” core inflation forecasts are steady at 1½-1¾% through 2006, yet the “market-based” version of the PCE chain price index is already at the upper end of that range, and I think that inflation fundamentals point to additional upside inflation risks.
In my view, therefore, the Fed would have to tighten monetary policy significantly further to come close to turning those forecasts into reality.
See Morgan Stanley Digest: http://www.morganstanley.com/GEFdata/digests/20050222-tue.html
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