Wednesday, February 3, 2010

Economics Group Weekly Economic & Financial Commentary

Economics Group
Weekly Economic & Financial Commentary
U.S. Review
Not All World Series are Won with Walk-off Home Runs

•This week’s GDP release was another single on the road to the economic recovery. There is no economic boom but continued progress is making itself felt. Consumer spending and business investment are two real positives.

•Housing remains an issue. While there has been some improvement the challenge for 2010 is how mortgage markets react to the end of the Fed’s liquidity injections to the secondary market. Our expectation is that mortgage rates will rise. The issue remains how much and how sensitive is housing demand to such a rise.

Economics Group Point of View Wells Fargo Securities, LLC
Interest Rate Watch
Fed Outlook: Better Growth –Light at the End of the Easing Tunnel?

Better economic times are ahead. That, at least, is the view from the Federal Open Market Committee and we would agree that the economic outlook continues to improve. Economic activity “continued to strengthen” according to the FOMC statement. Household spending continues to expand but with the drag of income, wealth and credit constraints. The story here though is the upgraded outlook by the FOMC for business spending on equipment and software. Orders and shipments reports have improved in recent months and that is consistent with increased capital spending. In the latest GDP release, real spending on equipment and software was up a solid 13.3 percent at an annual rate in the fourth quarter of 2009.

Inflation: What, Me Worry?
For at least the short-term, inflation remains “subdued.” Resource slack, measured by unemployment and capacity utilization, remains substantial. However, inflation expectations have started to rise when gauged by the five-year/five year forward rates. The TIPS ten-year inflation expectations measure continues to rise. For now, though, these increases are modest.

Three fundamentals suggest the outlook is for continued rising long-term rates even though we expect the Fed to retain its low federal funds rate target. First, as the outlook for growth improves the flight to safety trade will continue to decline.

Second, with expected consumer price inflation at 2 percent or more for 2010 and 2011 the 0.85 percent yield on the two-year Treasury makes no investment sense. Rising inflation expectations suggest that even some longer-term Treasury rates do not cover the inflation premium, thus investors will likely continue to move away from Treasuries across the yield curve.

Finally, Hoenig’s dissent suggests that at the FOMC meeting there was some discussion about the retention of the phrase “extended period” when referring to low levels of the federal funds rate. This extended period could allow the build-up of inflation pressures that would become difficult to control thereby letting the inflation genie out of the bottle. The period of easy policy is ending.

2010: Year of the Tiger or Asian Bubble?
Economics Group Topic of the Week Wells Fargo Securities, LLC

Chinese New Year will be celebrated on Feb. 14, and 2010 will be the Year of the Tiger. The sharp increase in Asian equity markets last year, and in some cases, in property markets, has some investors wondering whether 2010 will turn out to be the year of the Asian asset bubble. Are bubbles starting to inflate in Asia?

Probably not, at least not yet, in our view. Yes, some equity markets posted spectacular gains in 2009, but the increases only offset some of the outsized losses that were registered during the preceding year. Indeed, most Asian stock indexes remain well below the peaks that were reached in 2007. To help illustrate the trend in Asian stock markets, we constructed a capitalization-weighted index using some of the region’s key stock markets. The index does not alarm us, at least not yet. Although this index has nearly doubled since its nadir in late 2008, it remains about 25 percent below the peak it set in December 2007. How can Asian stock markets realistically be in “bubble territory” if they have not surpassed their previous peaks yet?

Similarly, some property markets (e.g., Hong Kong, Singapore and Shanghai) have experienced significant price increases over the past year. Again, however, prices in most markets are not yet back to levels that prevailed a few years ago. Asian economies, which experienced their own financial crises a decade ago, are not overly leveraged at present. One way to measure leverage in the banking system is to look at the overall loan-to-deposit ratio. The higher the ratio, the more the banking system is relying on borrowing from abroad to finance new loans. Not only have the loan-to-deposit ratios for some major economies in the region trended lower over the past decade, but they are all comfortably below 1.0 at present. In our view, asset prices in Asia have further room to rise over the next few years as the region releverages. Although Asia probably does not have generalized asset bubbles at present, it surely could have them in a few years if monetary policy remains too accommodative for too long.


No comments:

Post a Comment