June data indicates further slowdown in demand, particularly in the interest rate sensitive sectors. This is a textbook response to the Fed’s raising of interest rates. Nevertheless, an expected 4 to 4.5 percent growth of the economy during the just-ended second quarter is still too strong. On the other hand, June retail sales were disappointing to retailers. There is also some evidence that growth of corporate cash flow may start to cool off during the second half of the year.

The response to the June employment report was amusing. Markets responded almost euphorically to the modest 11,000 gain in employment. Many analysts concluded from this data that the Fed would not need to further raise interest rates. However, only a few caught sight of a critical detail: private sector job creation surged by 206,000, the soft overall number was due to a drop in Census workers hiring. There is probably no better example of temporary data than Census workers, since they only work for a few months once every ten years. The overly-optimistic response to the employment number is symptomatic of consumer sentiment. No one wants the party to end, especially the phenomenal rise in equity values. In fact, some analysts refer to the risk of a Fed-induced recession. It is like blaming the doctor for the patient’s illness. We really need to take a more balanced view of the economy, to avoid the dream-like reference to a New Economy, and to consider the possibility that the old economy may be overheating. It would also help to take a broader view of the economy and not react to every data release as if it was the final judgement for this cycle.

We think that the Fed is likely to raise the Funds rate 25 basis points in August. More importantly, we think the Funds rate will continue to rise towards the end of the year, whether the increase occurs in August or in November. Election year sensitivities may delay the Fed until after November. While the Fed is a professional organization, and acts accordingly, perceptions may be more important than the facts. If the Fed, in good judgement, were to increase rates just prior to the elections, such a move would be perceived as politically motivated.

Argentina met the IMF targets for the first half of the year. The fiscal deficit reached $2.4 billion, below the $2.7 billion target. On a sour note, unemployment increased to 15.5 percent and construction activity remains depressed.

Brazil’s current account deficit narrowed in the first five months of the year, on the strength of an improved trade performance. Brazil also surpassed the IMF fiscal target. The accumulated fiscal surplus for the first four months of the year hovered around 4.6 percent of GDP.

Mexican voters put an end to 71 years of PRI total dominance of Mexican politics, with the election of the opposition candidate Vicente Fox. President Zedillo promised a clean and smooth transfer of power. We do not expect major changes in economic policy under Mr. Fox administration, although greater emphasis on privatization can be expected. The new government will attempt to make a dent on corruption at all levels of government and to deepen the democratic structures in Mexico.

For more information on Mexico, see our Country Risk Sample.

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