Economists feel US consumers may pose the biggest risk to the US economy if spending starts to falte...
Economists feel US consumers may pose the biggest risk to the US economy if spending starts to falter as interest rates rise.
Richard Saunders, senior manager, investment management at Butterfield Bank (Guernsey), says: "During the second quarter, the US economy has delivered relatively robust growth, with first-quarter GDP growth revised higher from 3.5% to 3.8%. At the end of June, fourth-quarter 2004 growth was also finalised at 3.8%, higher than the initial figure of 3.1%, confirming the US economy's position as the fastest growing G7 nation in 2004, and underlining how important the world's largest economy remains in dictating investment market direction."
In response to this higher growth rate, the US is still on a course of raising interest rates. They are currently at 3.25% but could rise to 4% by the end of the year, and up to 4.5% into 2006.
David Marchant, head of international equities at Insight, says: "Higher interest rates can pose a risk to the economy. The main concern is for consumers as most are already heavily indebted already. This process cannot continue forever and, eventually, consumer spending will slow down. The consumer has already gone on longer than expected."
According to Marchant, it would be a big risk to firms if consumers decided to stop spending. Companies' earnings forecasts for the year have already been falling. Many, especially in the cyclical areas, have no pricing power because of global deflationary pressures. These companies are competing with the low-cost manufacturing bases of Asia and are finding it hard to increase profit margins in the US when cheaper goods can be made from China.
Saunders points out: "With consumers likely to come under additional pressure, it appears unlikely that companies will find it straightforward to pass on higher input costs, which will place profit margins under increased pressure. We have consistently outlined that corporate earnings reports are likely to become a key focus as we move through the year, and recent developments reinforce this view.
"From already record levels in 2004, expectations for US profit growth this year certainly look challenging. With margins still squeezed and end demand slowing, it will prove increasingly difficult for companies to meet analysts' expectations. That is not to say that equities must be completely avoided, rather investors should focus upon companies with stable earnings profiles and highly competent management."
Higher commodity prices could also pose another risk for the consumer. According to Saunders, after undergoing a short-term correction during the first half of the quarter, the price of oil has re-established its upward progression, adding to the debate over the inflationary outlook. As the consumer is already stretched with 12 months of interest rate increase, in this environment it is difficult to see how higher oil and gasoline prices can fail to have a dampening effect upon consumption, and this supports our view that US growth will decelerate in the latter part of the year.
However, Marchant does not feel there is much concern for the present inflation levels to start hitting consumer spending. Although there are some inflation pressures from higher commodity prices, it is not as yet feeding through into the consumer. Wage and employment growth is still reasonable, but this could be a risk for the future.
Consensus is that US interest rates will continue to rise into 2006, possibly as high as 4.5%.
Pressure on the domestic consumer, whose seemingly unstoppable confidence has so far protected the US against sharp falls
Higher commodity prices are another factor that could stop consumers spending.
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