May 15, 2002
U.S. EconomyThe Fed passed on an interest rate increase at the latest FOMC meeting this past May 7. Mr. Greenspan’s testimony before the Joint Economic committee of Congress on April 17 sheds some insights into possible future interest rate actions. According to Mr. Greenspan, the "behavior of inventories is the driving force in the near-term outlook." In addition, output per hour, or productivity, "rose at an annual rate of 5.5 percent in the fourth quarter of last year and appears to have posted another sharp advance in the first quarter [of this year]." Most importantly, "a striking feature of the current cyclical episode relative to many earlier ones has been the virtual absence of pricing power across much of American business." Viewed thus as an inventory correction, Mr. Greenspan’s view is that the current recession has not compromised the thrust of the surging productivity of the 1990s, and that the recovery will not encounter any inflationary pressures. Therefore, no interest rate increases are necessary in the next several months. However, we think it is more likely that the Fed will increase rates sooner rather than later.
We have labeled the current recession, which the National Bureau of Economic Research dated as starting in March 2001, as the "TV" recession. We have seen TV news and special reports about the recession almost every night, yet the economic data shows a different picture. GDP grew 1.2 percent in 2001, which was supposed to be a year of recession. The only negative figure was the third quarter, when GDP fell by an annualized rate of 1.3 percent, influenced in large part by the events of September 11, followed by a healthy 1.7 percent in the fourth quarter, and an unusually strong 5.8 percent in the first quarter of this year. The strongest contributions to growth in this year’s first quarter were from change in inventories, 3.1 percentage points contribution, personal consumption on non-durable goods, 1.66 percentage points, and government expenditures, 1.43 percentage points. Year-over-year, there has not been a single quarterly negative growth figure, and as of the first quarter of this year, GDP had expanded 1.6 percent with respect to the corresponding GDP figure for the first quarter of 2001.
The Labor Department’s recent news release that productivity had surged during the first quarter of this year bodes well for the outlook. However, the results for the past two quarters may not signal a definitive trend. Data on output per hour in the non-farm business sector published by the St. Luis Fed shows that productivity increased 2.1 percent in the fourth quarter of last year relative to the same quarter in 2000, and in the first quarter of this year, productivity was up 4.2 percent above the corresponding figure in 2001.
The health of the economy appears to have improved noticeably since the fourth quarter of last year, leading to robust expectations. According to the Wall Street Journal, most analysts expect 3.0 – 3.5 percent growth in the second quarter. However, we expect the economy to go through a zig-zag recovery of expansion and weakness, for the next several quarters. The inventory to sales ratio has remained at 1.39 since last October, down from 1.44 in January 2001. If consumer demand weakens, further inventory adjustments may be called for. Consumer debt service, at a historical high of 14.3 percent of disposable personal income in April, could deter future expenditure increases. Interestingly, consumer sentiment, as measured by the University of Michigan index, was up to 95.7 in March, from 81.8 in September of last year. We think the events of September 11, followed by the impressive success in the war against terrorism, contributed to a surge in consumer optimism towards the end of last year, and thus to a temporary buying splurge during the past two quarters.
On the other hand, inflation expectations have behaved erratically in recent months. According to the University of Michigan’s survey, consumer inflation expectations shrank from 2.8 percent in September to 0.4 percent in November, followed by an unusually sharp increase to 2.7 percent in March of this year. Contrary to the Fed’s view, we think inflationary pressures exist, and that they will materialize during the second half of this year. The risk of a sharp drop in the value of the US dollar, which we have been predicting for months, could also add to inflationary pressures. Higher inflation and a weaker US dollar would in turn push up interest rates.
Latin American Economies
The Andean Trade Preference Agreement (ATPA), which expired in December, is about to clear the final hurdle in the U.S. Senate for a ten year extension. It would allow free entry into the U.S. for about 6,000 products from Bolivia, Colombia, Ecuador and Peru.
Argentina’s economy is virtually paralyzed, while the government of president Eduardo Duhalde struggles to obtain fresh money from the IMF and to avoid a political meltdown.The Bolivian government is negotiating with Peru and Chile for access to a seaport on the Pacific, with the objective of exporting natural gas to the U.S. An additional possibility is the establishment of petrochemical plants to process Bolivian oil and natural gas. Substantial fees from the use of port and land are kindling the interest of local and national authorities in Peru and Chile.
The presidential elections in Brazil are beginning to unsettle the markets. Luiz Ignazio da Silva (Lula), the old leftist union leader, is ahead in the polls. Lula is favored by 39 percent of voters. His closest contender is Jose Serra, the official candidate, with less than 30 percent.
Chile’s Central Bank cut interest rates again by 75 basis points to 4.0 percent. Economic growth in Chile has been stronger than in most Latin American countries. However, at about 3.0 percent, it falls below expectation
Just after his inauguration, president Abel Pacheco of Costa Rica announced plans to cut fiscal spending, in an effort to reduce the fiscal deficit, and to sign a free trade agreement with the U.S. Costa Rica is the leading Central American exporter to the U.S.
The focus of attention in the Dominican Republic is currently on the municipal and Congressional elections, which are seen as a mid-term test for the current administration of Hipolito Mejia.
Guatemala’s president Portillo finally scored a victory, with the passing a long awaited banking reform law. The new law seeks to modernize the banking system and to give more teeth to supervisory authorities.
Minimum salary will go up in Honduras from about US$100 monthly to US$112. The agreement among labor unions, business and the government also calls for a one year freeze on prices of 16 basic products, electricity, water and telephone tariffs and urban transportation.
Mexico is still in recession. According to preliminary estimates, first quarter GDP contracted by 1.2 percent, from a year ago levels.
Widespread economic weakness still plagues Panama.