Creeping Specter of World Economic Slowdown
Sharp falls in equity markets around the globe, the $10 oil price drop from an all time high and the falling-off of US bond yields from 4.60 to 4.25% – all add up to a tremor rippling across world markets that is generated by fear of a slowdown in the making..
This fear is succored by a dangerous combination of factors: an expanding trade deficit, rocketing oil and commodities prices, a weak American labor market and, most of all, looming stagflation (inflation plus recession).
International Monetary Fund (IMF) heads gathered last weekend in Washington voiced concerns about growth, especially in the United States, under the burden of expensive oil and the soaring US trade deficit, which surged in February to the new all-time record of $61 billion. Finance ministers and central bankers from Europe, America and Japan, are deeply disturbed by high oil prices. Although oil fell back this week from its record $60 a barrel to below $50, a barrel still costs 50% more than it did two years ago. This poses a real threat to economic growth rates in developed countries led by America, Europe and Japan.
What world economic experts find most disturbing is the hint of stagflation in the United States posed by rising inflation (caused by spiraling prices of commodities and oil), unemployment and a weak labor market. The most serious aspect of stagflation is that it has no surefire economic cure.
US Federal Reserve heads have been combating inflationary pressures by periodically raising short-term interest rates. At the same time, consumers’ confidence is weak, as shown by the March retail sales figures (which gained only by 0.3% – about half the consensus). American labor market figures likewise show only a modest monthly growth of above 100,000 new jobs. This produces the very conditions which are making the markets so unhappy: inflationary pressure coupled with economic slowdown. Pushing interest rates up any further could further depress growth
Financial markets’ fast reactions
Equity markets around the globe tumbled during last week hitting 5-month lows. The Japanese stock market, a long-time favorite of debkafile‘s financial market analyst, sold off Monday, April 18 by 4% against the background of three weeks of violent anti-Japanese protests across China. Any damage to dynamic Japanese-Chinese trade relations now standing at $168 billion could send the slowly-recovering Japanese economy into a slump.
American equity markets declined sharply four days in a row – then perked up slightly.
As the season of quarterly reports approaches, investors worry that companies’ profits may be disappointing and not justify current share prices.
The bond market has tip-tilted in the last two weeks. American 10-year bond yields plummeted from a high of 4.65% to 4.20% during Tuesday April 19 trading. This reflects the altered expectations of continuing aggressive rises in interest rates – some even estimating the next hike on May 3 to hit 0.5% instead of 0.25% as heretofore.
These expectations have taken a knock from fears of a world economic slowdown. Investors therefore went back to the cozy safety of long-term bonds. Long term interest rates dropped sharply in consequence.
Foreign exchange markets still in two minds.
The US dollar slid again last week after the strong support levels of $1.27-1.28 per euro held steady. The week began with the dollar decline reflected in weakness in stock markets and the fall in long-term American bonds yield. Monday, April 18, the euro went up by 1.25% from $1.2880 to 1.3040 per euro. In contrast, currencies associated with global economic growth like the Australian dollar slumped on symptoms of slowdown against the American dollar and other currencies. Investors were drawn by their concerns for the stability of financial markets into the traditional safe havens of the Swiss franc and gold.
All financial markets have become more volatile of late, chasing like stampeding cattle from one attraction to another. One senior investor describes the markets as being “engulfed by wave upon wave of tsunamis.” This manifestation is caused largely by the heavy involvement of hedge funds in financial markets. The hedge funds are excessively leveraged, which means they are financed by as much as ten times (!) their capital value and make frequent acute turns – even in intraday trading.
The world’s finance ministers and central bankers are seriously troubled by the American economy’s structural problems, high oil prices and signs of global economic slowdown. But speeches aside, public iterations of concern have not translated so far into action to address urgent problems. Any further crises, like for instance a real estate recession, would make it even harder to take such action.
We therefore predict a hard time for equity markets, a consolidation period and possibly more declines in the future. Bond and foreign exchange markets may remain volatile:
10-year bond yield should move between 4.00-4.40%. The dollar is still groping for a support level between $1.27-$1.28 per euro and resistance levels of $1.31-1.32 per euro.
Contrary to most world markets, Israel’s economic figures continue to be good with the state budget in surplus and low inflation (The March consumer price index, CPI, was 0.2%.) Local capital markets enjoy strong buy recommendations from major foreign investment houses, like Merrill Lynch and Deustche Bank, which recently advised holdings in Israeli markets to be increased to above their weight in the emerging market index. This is one reason why the Tel Aviv stock exchange has consolidated lately between 630-660 points (on the Tel Aviv 25 index), and has emerged almost unhurt by the last sell-off in world equity markets. The crucial resistance level stands at 664 points (an all-time high).
Until last week, the Israeli foreign exchange market benefited from dollar strength around the world, surging to 4.40 shekels. But in the last few days, the falling dollar has restored trade to the narrow range of 4.37-4.40 shekel per dollar. Shrinking rate differentials between the dollar and the shekel support some dollar strength in the long term.
But it must be emphasized that all trends depend heavily on the security situation. Any resurgence of Palestinian terrorist attacks or clashes with Israeli troops before or during pullbacks could turn Israeli capital markets right round and point them in a negative direction.