Wednesday 14 May 2008

Slower growth and higher inflation in the US and UK, malaise for risky assets

Signs of a slowing US economy continue to show up. From Reuters:

The Commerce Department said retail sales declined 0.2 percent, but excluding cars, sales rose 0.5 percent...

Separately, the National Association of Realtors said median values of previously owned single-family homes in metropolitan areas fell 7.7 percent from year-ago levels.

But the expectation for a pause in the Federal Reserve's rate cutting remains, to a large extent because inflation remains a concern.

The Labor Department said U.S. import prices climbed 1.8 percent in April as prices for petroleum and non-petroleum products climbed, feeding worries about the potential for inflation...

Analysts said the retail sales numbers might increase chances that Fed policy-makers will pause their rate-cutting campaign and focus more closely on controlling inflation.

A survey by the Philadelphia Federal Reserve sees economists acknowledging both slower growth and higher inflation in the US. Reuters reports:

The U.S. economy will barely expand in the second quarter and the chances of it shrinking have risen, following sluggish growth early in the year, said a Philadelphia Federal Reserve survey released on Tuesday.

The 50 economists surveyed by the regional Fed also forecast a sizable pickup in overall inflation in the next several months as a result of surging oil and food prices...

They forecast U.S. gross domestic product in the current quarter would expand at an annualized rate of 0.2 percent, sharply below their prior forecast of 1.3 percent...

Forecasters revised upward the prospects of a contraction in the second quarter to 49.1 percent from their earlier projection of a 42.9 percent risk...

Core inflation will likely stay just above the top end of the Fed's perceived comfort zone of 2 percent in coming months. Forecasters raised their second-quarter estimate for the Consumer Price Index, the government's broadest inflation measure, to a 3.5 percent increase from their previous estimate of 2.4 percent.

Unlike the Federal Reserve, the Bank of England is early in its interest rate cutting cycle but it might already have to consider a pause.

There is little doubt that the UK economy is decelerating. From Reuters:

House prices suffered their most widespread decline across Britain for 30 years and retail sales fell for a second consecutive month in April, surveys showed on Tuesday, in a sign the economic slowdown is worsening...

The Royal Institution of Chartered Surveyors said its house price balance fell to -95.1 in the three months to April from -79.4 in March -- the weakest since the series began in January 1978 and well below forecasts for a reading of -80.0.

The balance fell in every region compared with March...

The British Retail Consortium said the value of like-for-like retail sales fell by an annual 1.5 percent last month.

Total sales, which include new floor-space, rose by 1.0 percent, the weakest annual rise in three years.

And from another Reuters report:

Property services firm Savills said its Total Commercial Development Activity Index showed a net balance of minus 20.8 percent last month -- the lowest level recorded in the monthly survey's five-year history and evidence that the country's property downturn has further to run.

But inflation is still headed in the wrong direction. Again from Reuters:

Soaring food and fuel bills pushed up the inflation rate by its biggest amount in nearly six years, further denting expectations of interest rate cuts despite a slowing economy.

The Office for National Statistics said consumer prices leapt 0.8 percent last month from March, pushing the annual rate up by half a percentage point to 3.0 percent. Analysts had expected a rate of only 2.6 percent.

The pound jumped more than half a cent and interest rate futures tumbled as dealers ratcheted down the probability of further interest rate cuts soon.

Morgan Stanley's Richard Berner sees slower growth and higher inflation as a global phenomenon with economic recoupling, and the impact on risky assets is not positive.

Global growth is slowing, reflecting spillovers from the US slowdown, tighter financial conditions, and the response to rising inflation in EM economies...

Ironically, the slowing in global growth could be the coup de grace for the US, just as it was the saving grace a year ago, and the evidence for such fading support is starting to appear in US exports...

Still-strong growth in much of the world and soaring commodity prices threaten higher global inflation...

Unfortunately, supply factors seem to be the dominant cause behind the rise in commodity prices lately...

Investors hoping for the ideal scenario of a mild global slowdown, a stronger dollar, cooling inflation, and lower interest rates abroad seem likely to be disappointed. The baseline I see will involve an unappetizing combination of slower growth, high inflation, and little decline in interest rates, which spells malaise for risky assets. In contrast, if overseas growth were to slow enough to bring down inflation and interest rates and boost the dollar, overseas earnings and credit quality would suffer significantly. Neither outcome seems positive for equities or other risky assets.

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