North America

  • Given the U.S. federal government’s expansionary fiscal policy and expected increase in military spending, the budget deficit is set to widen considerably, which will have to be financed substantially by foreign savings.

  • The wide current-account gap reflects high spending patterns by U.S. entities. In the late nineties, the inflow of funds into the United States was motivated by the desire to participate in a dynamic high-productivity-growth economy. Recent experience may have introduced some doubts in the minds of foreigners on whether the previous scenario may be reconstituted. But, for now, relatively poor prospects elsewhere have ensured that a large outflow of funds has not occurred.

  • At the present conjuncture, for better or worse, the world economy needs a high rate of spending by the American consumer, who continues to be the main driving force in the U.S. economy. The global system can tolerate weak growth in the United States but a dip into recession would have a more serious effect on the pace of activity everywhere.

  • The index of leading economic indicators has fallen for three months in a row, indicating the force of the headwinds facing the economy. Meanwhile, consumer inflation edged up higher than expected, though there was nothing particularly worrying in the development. At the same time, corporations are desperate to raise prices to shore up the bottom line.

  • Competitive pressures that keep prices low are exceptionally strong in the goods-producing sector. This may eventually lead monetary authorities to target a higher inflation rate to help raise the profitability of the corporate sector. At present, the low interest policy is helping firms deleverage (i.e. lower the proportion of debt in their capital structure) without undergoing undue stress.

  • After a number of disappointing earnings pre-announcements, expectations of a profit rebound in the third and even the fourth quarter have diminished. This, along with geopolitical uncertainties, has resulted in further lows in the major indices.

  • In the recently released Flow of Funds report by the Federal Reserve it is indicated that household net worth fell by $1.4 trillion in the second quarter. This was entirely due to the fall in stock market wealth. The ratio of household net worth to disposable income is at its lowest point since 1996, but is still held up at a relatively high level because of appreciation in the value of real estate.

Europe

  • Germany, the biggest economy in Europe, continues to show signs of weakness. Falling employment has affected consumer spending, while businesses are wary of increasing their investment expenditures. Meanwhile, bank lending to the private sector is contracting, as banks seek to maintain their profitability in the face of rising loan-loss provisions and declining equity prices.

  • Observers are already worrying about the risk of deflation in Germany. The financial structure, with its reliance on long-term financing at fixed rates, and comparatively high debt loads, makes debtors very vulnerable to deflationary forces. Also, given that the unionised labour force is relatively inflexible on wages, then the risk of high bankruptcy rates cannot be ignored.

  • With the deterioration in Euro-zone, and particularly German, economic prospects there is increased pressure on the European Central Bank to cut interest rates. Given the repeated negative surprises from data releases, they have already recognised downside risks to growth rates.

Asia/Pacific

  • The Bank of Japan has announced its intention of taking the unusual step of purchasing stocks directly from the banks, as a means of bailing them out. Given the amounts involved, it is intended as a short-term support of the financial system and not a boost for the stock market. Furthermore, it will not impact the monetary base and consequently the money supply. However, it will help the banks' capital adequacy requirements in the short term, but will do little to solve the central issue of the bad-loans burden.

  • Asian stocks which had last week risen on hopes for a peaceful resolution of the U.S.- Iraq conflict have now sold off as oil prices have headed higher again. Meanwhile, a weakening yen will start to affect East Asia's export pricing because of the need to stay price competitive. At the same time, export volumes to destinations outside Asia are already threatened because of the global slowdown.

Bonds

  • Investors’ risk aversion continues to motivate a strong demand for Treasuries. The yield on the ten-year note has plummeted considerably over the past five months. This indicates lower expected economic growth as well as discomfort with equity market valuations.

Currencies

  • Current short-term appreciation of the greenback is largely due to the weakness of other currencies rather than its own strengths. Versus the euro, the exchange rate has reflected disappointing European data releases but looking forward, if U.S. performance is sub-par there may be renewed interest in the Euro-zone currency.

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