North America

  • U.S homeowners continue to benefit from low mortgage rates, and with house prices still firm, their stake in home equity is sustained. Re-financing has served as a means of obtaining cheaper funds and an alternative to more expensive consumer loans.
  • The job market shows few signs of pointing to a strong rebound in employment growth. Firms have to watch their bottom line very carefully, so hiring decisions will be delayed.
  • Real wages have held up well, which has been positive for household spending but has constrained the ability of firms to increase their profits.
  • If sales growth were to pick up strongly, then corporate profits could initially experience a healthy rebound as cyclical slack is taken up and output increases at a faster pace than inputs. This is a real phenomenon that occurs in the appropriate phase of a normal cycle and is unrelated to accounting issues.
  • On a longer-term basis, productivity growth is likely to be somewhat less impressive than during the period of the late nineties. Earnings performance will depend mainly on cost-containment measures until productivity-enhancing innovative activity picks up.

Europe

  • In a generally weak global economy, exports are not going to pull the Euro-zone economy out of the doldrums. Unfortunately, domestic demand does not show signs of strengthening of its own accord either.
  • European fiscal policies may have to become a little looser but they are ultimately, though not dogmatically, constrained by the Growth and Stability Pact to keep deficits and debt levels within given ratios, relative to gross domestic product.
  • The European Central Bank has recognised that the Euro-zone economy is growing at a sub-trend rate, but demonstrates reluctance in cutting interest rates. Part of the reason is that unlike the Fed their focus of attention is more squarely on containing inflation than on enhancing growth. They are willing to tolerate downside risk for the latter rather than upside risk for the former. Top ECB officials are better protected from political fallout than their Fed equivalents.
  • Households in most European countries are less interest-rate sensitive than their counterparts in the United States. There is less mortgage refinancing when rates fall - - and relevant interest rates have indeed declined in Europe - - than occurs in North America.

Asia/Pacific

  • After plummeting to new lows the Nikkei 225 has managed a rally that is, however, not based on fundamental factors. The index rallied on expectation of stock-price supporting measures by the government. It is designed to support Japanese companies’ semi-annual book closing at the end of this month. The anti-deflation package will have a short-term impact and nobody pretends that it will have lasting consequences.
  • In August, bank lending in Japan shrank 4.5% year over year, showing that the demand for funds is quite weak. Meanwhile, the domestic wholesale price index fell, last month, indicating that deflationary pressures are likely to be sustained.

Bonds

  • The Fed is still on an easing bias and is watching consumer behaviour carefully. The market has now reduced its expectation of a rate cut at the September meeting of the FOMC. Any changes in this regard will push down short rates, steepening the Treasury yield curve at the shorter end.
  • Policymakers have to make careful strategic choices about how to employ any remaining interest rate cuts. However, fears of a liquidity trap in which the economy fails entirely to respond to the lowering of interest rates, from already low levels, bears consideration but may still be a little exaggerated.

Currencies

  • The vigour of growth in the U.S. economy, for the remainder of this year, depends on the American consumer. If the conflict with Iraq goes well and the growth rate significantly outperform that in Europe, then the sentiment towards the dollar may improve somewhat, despite the fact that it is a deficit currency.
  • If the U.S. consumer slips badly and interest rate reductions become ineffective as policy measures then the main recourse to stimulate the economy, apart from expansionary fiscal policy, may be via a fall in the value of the dollar.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.