North America
- Equity investors in the U.S. are still flush with positive sentiment and are looking right past the bad economic news. Expectations of Fed easing are widespread and are helping to sustain the upbeat mood. Also, seasonally, this is the right time for an upswing in the market - - and lots of people are aware of, and banking on, this phenomenon. Looking further forward, next year will be the third year of President Bush's term and traditionally stocks have gone up in the year before a presidential election. So, currently, investors may just be acting on their belief that everything will turn out to be all right. It is not a demonstration of exceptional collective prescience about the outturn of events. Orthodox fund managers are doing what they usually do, namely, follow the crowd.
- American equity investors have doggedly maintained their faith in the stock market, despite the drubbing of the last few years. There is still an underlying belief that the "good times" will return. People have not yet adjusted their longer-term expectations towards more modest average stock-market gains. They want to enjoy a very comfortable post-retirement standard of living, without cutting back on their current high rate of consumption. For a time, in the nineties, the prospects looked very good - - then, turbulence hit. The baby-boomers’ collective hope is that the previous happy state of affairs will soon be reconstituted. This explains the undiminished faith in quick returns from technology and the fear of missing a sustained upswing in the market. Meanwhile, households would do well to think about paying down the principal on the big debt load that they have accumulated.
- After the big build-up in expectations prior to the FOMC meeting on November 6, the Fed is not going to disappoint and is likely to be generous rather than stingy in presenting a rate cut. This will help sustain confidence and stock market valuations but won’t do much to fire up spending, particularly from corporations. We should not dismiss, out of hand, the psychological effects of a confidence-boosting move on spending decisions. But it is difficult to see a quick turnaround in capital spending in the current climate of uncertainty. The fact remains that at these low rate-levels, monetary policy is relatively ineffective.
Europe
- It looks like growth momentum has slowed substantially in the Eurozone economy, and in some of the core economies, such as Germany, the manufacturing sector is in outright recession. Unfortunately, there isn’t going to be a big upside for the E-12 economy in the first quarter, either.
- The output gap between actual and potential GDP growth has widened and, with core inflation set to decline, there are very good reasons why the European Central Bank should cut interest rates. Expectations have been rising for a fifty basis point reduction before year-end. The timing is a little bit in doubt and may be related, in part, to expected assurances from finance ministers on the integrity of the Stability and Growth Pact. A coordinated cut, this week, in conjunction with the Fed and the Bank of England, would be particularly encouraging for equity markets.
Asia/Pacific
- With more and more forecasters downgrading expected U.S. growth in the first quarter of 2003, the prospects for non-Japan Asian exports to the United States are looking increasingly dim. This will crimp overall GDP growth, which should, nevertheless, perform creditably due to inter-Asian trade holding up well. Meanwhile, where feasible, Asian central banks are likely to trim interest rates, in keeping with the current global trend.
- The Bank of Japan has little room to lower rock-bottom interest rates, which unfortunately are not particularly low in real terms because of continuing deflation. But the BoJ has engaged in a dose of quantitative easing by upping the target for banking-system reserves and increasing the outright purchases of government bonds (JGBs).
Bonds
- Heavy Treasury supply is putting some upward pressure on yields, as the market tries to digest the offerings. At the same time, with the Fed in cutting mode, a steep yield curve is still the order of the day. Volatility is unlikely to diminish in the short term, but once we get past the major auctions, continuing bad news on the economy will see yields head lower. Significant relief for the wide corporate spreads isn’t in sight either.
Currencies
- The euro has broken through parity level with the dollar, despite the ongoing rally in the U.S. stock market. As a major debtor currency, slow growth in the United States weighs more heavily on the dollar than the poor performance of Eurozone economies. In addition, the decline in oil prices reduces the demand for dollars.
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