CompareForex - FX trading news

Economics
Domestic and global economic snapshot
May 15, 2008
Clifford Bennett, Chief Economist, Sonray Capital Markets

Monday’s lending data for homes and investment suggests the “Australian Growth Bubble” may be about to burst. There is no doubt whatsoever that the RBA has overcooked the goose by not allowing full time for previous rate hikes to flow through the economy.

To ignore the ominous global environment, as well as what were already clearly falling home prices in many Australian suburbs, was to do so at its own peril. In 2006 when falling home prices had started to eat away at the periphery of US economic society, the Fed maintained the same stoic focus on inflation, as the RBA has done this year. The RBA has badly mismanaged the current hiking cycle, where the downside risks to the economy far exceeded the upside risk to inflation, even before the year began.

Inflation will probably peak this quarter, and may have even done so in Q1, with or without the RBA’s heavy handedness. Inflation in modern economic times is determined by the market force of competitive pricing, unlike ever before. This is why we have high productivity. It is the only way for businesses to maintain profit margins while commodity/input prices rise. All the RBA’s rate hikes have done is to hurt those least able to respond. Working families suffering under what were already difficult mortgage rates at year-end, were further hard hit with rate rises by the RBA, and from their banks as a result of the global credit crunch.

The error the Rudd/Swan government has made, is to endorse and enhance the independence of the Reserve Bank, while lambasting the domestic banks who have simply been trying to squeeze between the RBA, and the global credit crunch, at the same time.

Monday’s data also confirms the crucial nature of the Rudd/Swan government’s first budget. Some of the economy’s wheels are already wobbly courtesy the RBA, and this budget needs to maintain the spending power of middle Australia, not just for political reasons, but for the country to avoid the “recession it does not have to have”. Fiscal surpluses need to be maintained for the formidable but not insurmountable task of resolving the infrastructure bottlenecks facing our commodity producers, but equally importantly middle Australia must be supported through what is potentially a significant economic slowing through 2008 and into 2009.

While some measures in this budget may not be perfect trickle-down economics, we may all come to appreciate the support of middle class consumerism that it hopefully contains.

Global snapshot

The productivity data in the US highlights the squeeze that manufacturers, and all business, are experiencing between higher input prices and competitive consumer or output price pressures. Since 1999 I have argued inflation was a dead animal as for the first time there are true competitive price pressures now as a result of modern communications and particularly the internet.

US data confirms my long held argument that productivity is high by historical averages because the only way to maintain a profit margin against a rising tide of input prices is just that, improve productivity. As such the data in no way suggests a strong or even firm US economy. What it does confirm is the on-going desperate search to maintain business revenue and profits, by holding down prices and increasing productivity.

As for the boom in consumer credit I have previously written about the last hurrah or more poignantly the last “gasp” of the US consumer. Consumers the world over are more aware and better educated than ever before, and nowhere is this perhaps more acute in terms of consumer purchasing behaviour than in the US. The US consumer is smart enough to recognize that access to credit will be diminishing, therefore the smart idea is to get that new car while cheap credit deals remain, and a few durable goods as well perhaps, then bunker down for the on-coming economic winter! That is what all the data is suggesting at the moment. It is akin to a bear market rally. The data will have a last moment improvement before the US economy tailspins to recession or worse. Since September 2007 we have forecast the US economy to remain stagnant through the first half of 2008, and more recently extended that to all of 2008. This last hurrah type data we are seeing at the moment, is a warning that a long lasting recession perhaps worse is a real risk now, a greater risk than we had previously envisaged.

The outlook for the US dollar remains dire. It has nothing going for it at the moment except the misplaced belief that because the Fed is behind the curve, forced to cut rates dramatically, it will be the first to hike again. The Sonray forecast remains further and now non-consensus rate cuts by the Fed. In fact the pause at 2.00% allows the Fed to maintain some heating oil of its own in case a deep economic freeze hits the US in the middle of their summer. The full extent of the credit crisis globally will not be known or declared until July. This will continue to have some global impact. For the US however the plight of falling home prices and consumer hesitancy will last well through year end. Mid-year could be crisis time for the US economy, and that is when the Fed may be forced to cut rates yet again, to 1.50% or even 1.00% by Q3.

Meanwhile the ECB has had the ability through less volatile monetary policy over several years to hold the middle ground. While it remains aware of both price and growth risks, it can continue to observe rather than react for the moment. We expect the ECB to remain on hold through the year, and if anything the next move by the ECB is likely to be to raise rates. The decoupling of the rest-of-world economy from the over mature US economy remains in place and becomes clearer every day. The Euro will continue to strengthen from its new status as preferred reserve currency, but the overall dominant global story for currency markets remains a declining US dollar. We expect the Euro to move toward 1.6200 after this current correction. Around 1.62 1.64 is where co-ordinated intervention is a possibility, but this would merely delay by 3 to 6 months further US dollar decline to around Euro 1.8500 in 2009.

Fortunately for equity markets the decoupling of the rest-of-world economy from the US, combined with the fact that the large US companies are truly global in terms of revenue streams, should mean that they fair far better than the US economy. For the Dow Jones a rally to 13,400 13,500 before a mid-year self off seems a reasonable expectation.

Subsequent to all the above, continued uncertainty and a falling US dollar, all add up to a much higher Gold price than so far seen.

Aussie dollar forecast at US$1.01 by year end

The medium to long term outlook for the Australian economy just got a whole lot better. This Federal budget is most certainly not incremental. Massive commitments such as A$20 billion to commodity infrastructure development will have a major impact, and Australia will at some point perhaps be able to deliver as much as China and the rest of the world desires. Effective currency hedging combined with the reduction in bottlenecks should ensure a prosperous nation for decades to come.

But lets get back to currency markets today and in the context of the manageable future. The big story remains the long term decline of the US dollar which still has a way to go, perhaps to Euro 1.85 and 2.05 in the next 1-3 years. That means an increasingly efficient door-step-of-Asia commodity producer, with a central bank reading from antiquated texts and delivering above necessary interest rate yield levels, will remain irresistible temptation for any major money manager.

The Australian dollar is confirmed as a quality investment asset with long term hold/buy printed all over it. For some time now we have been talking about how the nature of Australian dollar has shifted from being dominated by short term speculative, or so-called hot money buying, to the realm of the long term global portfolio managers holdings, and even perhaps to the stable of the odd central bank.

We continue to argue that the new asset class, post equity and property booms, is sovereign risk. The by far most efficient way to be involved in this new asset class is via currency markets. As the massive herd of global investors and traders moves into currency markets, one of the bright stars from the southern hemisphere is the Australian dollar. As the budget settles in, people will increasingly see how it reassures global investors of our long term economic integrity.

Any wonder our Australian dollar forecasts remain US$1.01 by year-end, and US$1.08 in 2009.

Clifford Bennett, Chief Economist, Sonray Capital Markets.

Disclaimer: This recommendation has been issued on the basis that it is only for the information and exclusive use of the particular person to whom it is provided by Sonray Capital Markets Pty Ltd ABN 18 104 482 993, AFSL 231151. These recommendations are current as at the date of issue. Past performance is no guarantee or reliable indication of future results. Trading in derivatives may involve a high degree of risk and significant loss, and is appropriate only for persons who can assume risk of loss in excess of funds deposited. This recommendation is of the nature of general information only and must not in any way be construed or relied upon as legal, financial or professional advice. No consideration has been given or will be given to the individual investment objectives, financial situation or needs of any particular person. The decision to invest or trade and the method selected is a personal decision and involves an inherent level of risk, and you must undertake your own investigations and obtain your own advice regarding the suitability of any investment for your circumstances. Although the information in this recommendation has been obtained from sources considered and believed to be both reliable and accurate no responsibility is accepted for any opinion expressed or for any error or omission that may have occurred herein.