January 16, 2002
U.S. EconomyThe Fed’s persistent statements that the principal risk to the economy is a longer and deeper recession and that inflation is non-existent, leads us to conclude that the FOMC will vote in favor of lowering the Fed Funds rate another quarter point to 1.50 percent at its January 30 meeting. The markets have a mixed view on this issue as the February Fed Funds futures is currently trading at 1.63 percent.
We think the markets are nonchalant about any inflation risks. In fact, consumers’ short-term inflation expectations, as reported by the University of Michigan survey, show a very unusual drop from 2.8 percent in August to 0.4 percent in November. The only other time that inflation expectations fell notably was several months before the start of a deep recession in 1982. Thus the latest inflation expectations data would point to a very deep recession in 2002. On the other hand, we think consumers have been convinced by the Fed that inflation is no more. With the CPI averaging 2.8 percent inflation in 2000, we fail to see the logic in consumers’ recent shift in expectations. A seldom-watched indicator of inflation is unit labor costs in the non-farm business sector. During the third quarter of last year this index was up 7.3 percent compared to the level of the index in the previous year. During 2000, the index expanded by only 2.3 percent. We think inflation will touch bottom at about 2.7 percent, and start to move back up to the 3.0 - 3.5 percent range, unless the economy falls into a deep recession.
The latest Wall Street Journal survey of Blue Chip forecasters predicts a very shallow and brief recession with GDP taking off during the second quarter with 2.4 percent growth. Based on this forecast, the annual average growth rates for 2001 - 2002 would be 1.0 percent for each year. We differ with this view and expect average GDP to decline by 0.7 percent this year. Continued declines in industrial production could push the economy further into recession. The Blue Chip inflation forecast is a modest 1.4 percent.
The fall in oil prices has helped to bring down the trade deficit to an annual level of $437 billion in October, from a peak of $455 billion in April of last year. The price of oil (West Texas Intermediate) fell from $28 per barrel in June to $19 by December of last year.
Latin American Economies
Commentary On Argentina's Crisis:
The serious economic and institutional crisis in Argentina merits a commentary about its effect on other Latin American countries. In fact, the effects of the Argentine crisis, which we had been predicting for quite some time, were being felt by neighboring economies with strong ties to Argentina, since early 2001. Economic activity in Paraguay and Uruguay, which depend heavily on Brazil and Argentina, has been in a slump for a long time. The currencies of Brazil, Argentina’s main trade partner, and Chile took a serious beating throughout last year. Other economies in the region, including Mexico, have been more affected by the U.S. recession and the global economic slowdown, than by the events in Argentina. In a rather surprising turn of events, the Chilean peso and the Brazilian real were actually strengthening in recent weeks, as the crisis in Argentina worsened. We believe that the reason for such improvement is that the markets had already discounted a devaluation and default in Argentina. Although a very important factor has also been the strength shown by both the Chilean and Brazilian economies under pressure, which can be attributed to their excellent economic management.
Brazil and Chile are not really immune to the Argentine crisis. Their stock markets will still be negatively impacted, as investors unload the shares of companies with significant exposure in Argentina. However, the more prolonged and important effect would be on trade flows, as Argentine demand will take a long time to recover. A U.S. rebound in the second half of this year, should come to the rescue. The real could come under pressure again, if the Argentine peso fails to stabilize, because Brazil would have to adjust its currency accordingly. As we mentioned above, the other countries should not be deeply affected. It seems that the markets are learning to differentiate between Latin economies and, this time, a contagion effect could be avoided.
Monthly Comments:
In the midst of a chaotic social and political upheaval and as we had been predicting since January 1999, Argentina formally devalued its currency, putting an end to a ten-year peg to the US$. At the same time, the government stopped payment of its foreign debt obligations, pending rescheduling negotiations with its creditors.
The draconian adjustment measures enacted by the Economy Minister, Domingo Cavallo, triggered massive protests, that eventually led to his resignation and that of President Fernando de la Rua. In accordance to constitutional procedures and in the absence of a vicepresident, the Chairman of the Senate, from the opposition Justicialista Party, became temporary President, only to resign in a matter of hours. In just a few days, the presidency changed hands four times. Finally the Justicialistas chose former presidential candidate, Eduardo Duhalde, to complete the remaining two years of de la Rua’s period. It was Duhalde who made the decision to devalue the currency.
Argentina is the only country in this Hemisphere that after experiencing a banking crisis has tried to force depositors to pay the loses incurred by the banks. Deposits are still frozen, while the government looks for a formula to rescue the clobbered banking sector. A two-tier currency system is now in effect, with a fixed exchange rate of 1.40 pesos per US$ and a floating rate, which rapidly sank to about 1.67 pesos per US$.
The economic and social situation in Argentina remains extremely fragile, as street demonstrations continue and the government struggles to impose a new economic order. The Argentine authorities have shown an appalling lack of preparation for this contingency, despite the fact that a default and a devaluation have been looming in the horizon for a long time. The management of this crisis, on the economic and political fronts, can only be described as shoddy and embarrassing.
The crisis in Argentina has been curtailing family remittances from Bolivian citizens working in Argentina, many of which are returning to Bolivia. The authorities are taking stricter measures along the border with Argentina, to stem the wave of smuggling. Argentine products are being illegally introduced in Bolivia, in exchange for US dollars.
Brazil and Chile are feeling the effect of the Argentine crisis mainly in the stock market, where the shares of companies with heavy exposure in Argentina are taking a beating. However their currencies have been strengthening. The Brazilian real was trading at close to 2.36 per US$, up from a trough of about 2.70.
Last minute efforts of international peace negotiators and the Catholic Church managed to keep alive the peace talks between the FARC and the Colombian government. So far, the peace negotiations have not produced any tangible result.
The latest opinion polls indicate that February’s presidential elections in Costa Rica are likely to go to a second round. The official candidate, Abel Pacheco is the front leader with 32 percent in preference. The candidate of the other traditional party, Partido de Liberacion Nacional (PLN) is in second place with 24 percent. But, Otton Solis, from Accion Ciudadana is making a surprising good showing with 20 percent.
The government estimates growth between 2.5 - 2.8 percent last year in Dominican Republic. However, GDP growth has slowed down sharply this year, with key sectors, such as construction, manufacturing, commerce and tourism on a downward trend. More than 30 free zone companies had to close down, due to the drop in U.S. demand.
Inflation in Ecuador remains above 20 percent and the price of an Ecuadorian oil barrel fell to $13.40 in November from $29.40 in the same month of last year.
The Salvadorean economy was growing by 1.6 percent in the third quarter, led by construction, which is in turn, being boosted by the reconstruction from last year’s earthquake.
The economic slowdown continues in Guatemala. According to official estimates, the economy grew by about 2.5 percent in 2001, which is below the 3.6 percent posted in 2000 and a far cry from 4.9 percent in 1995. About 20 maquilas closed down, due to the drop in U.S. demand, while coffee exports slumped. According to the latest opinion polls, president Alfonso Portillo obtained an approval rating of just 18 percent of the population.
Preliminary official estimates indicate that the Jamaican economy expanded by about 2.0 percent last year, thank to a strong performance by the bauxite sector and by agriculture.
Despite its present economic woes, Mexico was the main recipient of foreign investment in the region last year, with a total of US$24.5 billion.
The resignation of the chairman of the Nicaraguan Legislative Assembly, Oscar Moncada, opens the door for the election of former president Arnoldo Aleman as head of the legislature, despite the opposition from current president Enrique BolaZos.
Panama and the IMF will start negotiations for a new agreement in February. The government could not balance its budget, as established by the previous agreement. In fact, the budget deficit for last year is estimated at about 2 percent of GDP, while the economy grew by a paltry 1.0 percent.
The economy has been gradually expanding in Peru in the last quarter of 2001, but not enough to post a decent growth in 2001. Political stability and an unfavorable external environment combined to impede a stronger performance.