Given the weaker readings of leading indicators for the US economy, we are becoming increasingly int...
Given the weaker readings of leading indicators for the US economy, we are becoming increasingly interested in the consequences of a US slowdown next year. Forthcoming US employment statistics should provide more clues.
The recent fall in the Nasdaq raises the prospect of a slowdown in retail sales as the past correlation of the two has been high. High oil prices have also been associated in the past with weaker retail sales as higher fuel prices reduce consumers' disposable income. Despite high oil prices other commodity prices are slowing.
Monetary conditions are increasingly restrictive. The real Federal Funds rate (currently 6.5% Fed Funds minus 2.5% core consumer price index) at 4% is relatively high and should slow the consumer. Junk bond yields have widened considerable on fears of deteriorating credit quality. Banking exposure to the telecoms sector has been questioned and signs of financial distress are evident.
The spread on emerging markets debt has widened slightly but is well below the levels seen during late 1998, and a risk of contagion exists, especially as regional issues are undermining confidence in the Latin American markets.
The shape of the US yield curve implies a sharp slowdown in US GDP, although buy-backs in US Treasuries could have over-exaggerated the projected slowdown. Money supply figures are also slowing after peaking late last year on year 2000 concerns. The Federal Reserve's tightening bias would probably be lifted if it wasn't for the US elections and high oil prices.
US interest rate expectations (as measured by one year forward minus 0.25%) now reflect cuts in the Fed Funds rate. Equity markets movements are increasingly volatile, driven by daily developments due to greater levels of hot money.
Greenspan is likely to cut rates in reaction to any emerging hard landing, but there are doubts as to whether the benefits of this could be derived quickly enough.
The strength of US GDP and high levels of US productivity have helped attract the finance necessary to fund the current account deficit. Any changes to these factors or a weaker dollar might require higher interest rates. This could well pose a dilemma for the Fed. However, a weaker dollar would be welcomed by many exporters.
Bond markets are fairly fully valued, with many markets beginning to price in interest rate cuts. Weaker growth is not perceived as necessarily positive for bond markets as the scope for government buy-backs would be reduced. We feel that steeper yield curves will be the most likely result from slower growth.
For balanced funds we will widen our target underweight in the US and overweight in Europe for the time being to reflect the changes in benchmark weights.
John Richards, joint managing director SG Asset Management
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