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ARTICLE · 13 NOVEMBER 2002

LOM Weekly Perspectives - Financial Summary on North America, Europe and Asia-Pacific Regions

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North America

  • As we expected, the Fed turned out to be generous last week. But once the equity markets got what they were clamouring for - - and a bit more than most had dared hope - - they began to have second thoughts about the state of the economy, which even the optimists admit, is none too robust. As well, the FOMC shifted its previous easing bias to neutral, seeming to indicate that they will be on hold for a while. In fact, as mentioned before, the monetary authorities don’t have a careful long-term game plan and are ready to react to events as they arise.
  • The probability that consumer spending is going to fade, has increased. There is not much more to be got out of mortgage refinancing and there has been a good bit of front-loaded spending on autos. In other words, much of the normal upswing in these two big items, based on low interest rates, has already taken place. It is difficult to argue that there is much pent-up demand left in these two areas. Meanwhile, the employment picture for households isn’t improving any.
    • The problem for policymakers is that capital spending shows few signs of picking up to replace weakening consumption. We have argued before that there are no strong reasons for businesses to ratchet up spending, until they get a better handle on the risks they face. Consequently, with monetary policy relatively ineffective we should expect fiscal policy to step into the breach and help the recovery. Expect the government budget deficit to widen dramatically and probably surprise even the pessimists.
    • Things are going the way of the Bushmen, having got backing from the UN Security Council on Iraqi disarmament. They are likely to pounce as soon as Saddam makes a false move. There is little doubt that this administration has an agenda that goes well beyond Iraq. They would like to effect regime change in a number of countries - - by forceful means, if necessary. But it is not yet clear whether they have thought out a coherent strategy that will avoid them getting involved in a large number of expensive and open-ended problem-cases. If they get it wrong, markets will have to adjust to extended geopolitical uncertainty and deteriorating budget deficits.
    • The inflation/deflation debate continues among analysts, as well as the financial press, with deflation being the primary concern. First of all, we should make a distinction between disinflation and deflation. Japan is experiencing deflation (a decline in the price level) while the United States has had a run of disinflation (declining inflation). Looking more closely at the U.S. picture, we discern that the goods sector has experienced actual deflation, but in the very large services sector inflation is running at a relatively nifty pace. Averaging the two makes the headline figure look quite low.
    • There is substantial fear of general deflation in the United States because such an outcome would be devastating for debtors, and it is no secret that the household and the corporate sectors are both highly leveraged. As a result, there is great motivation among policymakers to slant the risk towards higher rather than lower inflation. Foreign creditors should be wary of such an eventuality, longer term, because they may end up paying the cost twice - - once through higher-than-expected inflation and again through a lower dollar.

    Europe

  • The European Central Bank disappointed observers by refusing to budge - - for now. How different from the gun-toting Fed that is willing to use bullets freely, even though it has only a few left. The ECB is still a bit worried about rising budget deficits threatening price stability. However, it is likely to relent before the end of the year and deliver an interest rate cut.
  • There is not much in the way of a fiscal stimulus emerging in core Eurozone countries, even as their deficits widen as growth stalls. Germany, with one of the weakest economies also faces the biggest fiscal challenges, in the form of rising deficits.

    • Asia/Pacific

  • Even a modest plan to solve the banking sectors’ non-performing loan problem will intensify the deflationary forces already prevalent in Japan. There is not much room to expand fiscal policy, which puts the onus for counter-deflationary measures on the Bank of Japan.

    • Bonds

  • Currently, the fed-funds rate is below the rate of inflation. Meanwhile, with bond-market expectations of further Fed rate cuts now on the back burner and the economy looking weak, investors have moved further up the Treasury yield curve, resulting in a bullish flattening.

    • Currencies

  • The dollar-weakening trend, particularly versus the euro, continues on currency markets, as the prospect for a turnaround in U.S. economic growth dims. The Fed rate cut was just seen as a confirmation of the belief that the American economy is struggling.
  • The lack of appetite for U.S. assets is leading to a strengthening of the yen, but this is likely to prompt official intervention on the foreign exchange market to curtail the rising value of the Japanese currency.

    • The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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