March 28, 2006
U.S. Economy
As we had predicted, the Fed raised the Funds rate to 4.75 percent at today’s FOMC meeting, thus further tipping the negative slope of the yield curve. We think the Fed is likely to further raise the Funds rate to 5.00 percent at the May or June meeting and the likelihood of an additional increase during the second half of the year will depend on inflationary trends, economic growth, and whether the long-end of the yield curve begins to move up.
The economy took a breather in the fourth quarter as GDP growth slowed to a 1.6 percent annualized rate. Consumption spending retrenched mostly through a sharp cutback of 42.7 percent in purchases of motor vehicles. Consumption expenditures on non-durable goods actually expanded at a healthy rate of 5.1 percent. The impact from the damaging hurricanes was also a contributing factor to the slower growth rate.
Market expectations for GDP growth this year are moving closer to our earlier predictions of 3.2 percent. Industrial production is trending down as shown by the 12 month growth rate which fell from 4.4 percent in December 2004 to 3.5 percent last December; and we expect the rate to further slow to 3.3 percent by June of this year. Within manufacturing, makers of computers and electronic products continued to post healthy growth. The tail end of the housing boom is still supporting increased demand for home appliances and furniture.
The correction or contraction in the housing market may not be far off. Rising interest rates, higher home prices, and lower levels of mortgage applications have cast doubt on the outlook. Housing starts as well as new and existing home sales started the year on a downward trend. The National Associations of Realtors still expects a soft landing this year, with sales of existing homes falling only 5.7 percent.
Retail sales for January - February point to a strengthening of the economy during the first quarter of this year compared to the fourth quarter. On the other hand, consumers are carrying a negative savings rate which stood at -0.7 percent of income. While surging home values have helped spur continued consumer spending, a correction in that market could cool off retail activity.
Inflation has been trending up, as oil prices remain persistently high. Our moving average CPI rate was 3.5 percent in February and is expected to peak at 3.6 percent in June before slowing to a 3.2 percent rate by the end of this year. This trend has Fed officials worried, at least in the short-term.
The world savings glut has become the magic word to support the U.S.’s reckless reliance on foreign financing to cover its hemorrhaging in the external accounts, although we think a good part of that so-called savings glut is sitting at the Central Banks of the surplus countries. While currency adjustments in China and other markets are quickly dismissed as too disruptive, we think market participants will become much more disruptive when they decide it is time to take the dollar down to its appropriate value. China would prefer not to revalue its currency in order to avoid the loss of jobs; however, as the experience of emerging markets has demonstrated, management of the currency is not a viable instrument to achieve employment targets. We continue to view a sharp fall in the value of the dollar as one of the principal risks to the economic outlook, which could then trigger a spike in the long end of the yield curve.
Latin American EconomiesArgentina
posted an excellent GDP growth of 9.1 percent in 2005; however, high domestic demand is fueling inflation. The government is signing price control agreements with commerce and industry leaders, in an effort to (temporarily) put a harness on inflation.New
Bolivian president, Evo Morales, was inaugurated on January 22. His Cabinet is composed of largely inexperienced officials, extracted from the diverse indigenous groups and labor unions that support him. Morales’ political party, Movement Toward Socialism (MAS) a coalition of a number of parties and organizations, obtained a majority in the House of Representatives, but fell short of a majority in the Senate. However, MAS has been promised the support of two other political parties with one vote each, which gives it the magic number of 14 out of a total of 27 votes in the Senate.During the presidential campaign, President Lula will certainly have to explain the lackluster growth of the
Brazilian economy under his watch. This year, economic activity should benefit from interest rate cuts and an increase in the minimum salary.Chilean
president, Michelle Bachelet, inherited a country that is the envy of many in the region, with a solid economy and social stability.President Alvaro Uribe obtained a solid majority in both Houses of Congress in
Colombia. He is expected to easily win the presidential elections set for May 28.Costa Rican
presidential elections were closer than anticipated by the opinion polls. Former president and Nobel Prize winner, Oscar Arias, managed to win by a very narrow margin over Otton Solis.The
Dominican Republic posted the highest GDP growth in the region last year with 9.3 percent and also complied with all IMF targets.Violent protests erupted in
Ecuador against the possibility of a free trade agreement with the U.S. Road blockades impeded the transportation of goods for a few days.The governing ARENA won the congressional and local elections in
El Salvador. ARENA obtained 34 out of 81 seats in the National Assembly, but will have a comfortable majority with the support of two other conservative parties.Honduran
former president Ricardo Maduro handed over a much improved economy to his successor, Manuel Zelaya. Under Maduro, the budget deficit was reduced from 5.2 percent of GDP to 2.5 percent last year. Economic growth is expected to have surpassed 4.0 percent in 2005.In
Mexico, PRI candidate Roberto Madrazo has not been able to generate much enthusiasm among voters. The leading candidate continues to be Manuel Lopez Obrador, followed by PAN candidate Felipe Calderon.Latest polls in
Peru indicate that populist candidate Ollanta Humala has been gaining ground against conservative candidate Lourdes Flores. He appears now in first place with Flores in second.Venezuela
has turned into the most important buyer of Argentine bonds. The government then sells the bonds to local banks and they in turn sell them to their clients who have an appetite for dollar denominated assets. The banks’ clients pay in bolivares and they in turn can sell the securities in any global financial market where the bonds are listed and receive payment in hard currency.