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Market View this week (30 June – 4 July 2008)
An early US rate hike remains unlikely. The Fed kept rates on hold this week at 2% and in the FOMC statement expressed more concern about inflation - although it fell short of moving to an explicit “tightening” bias. The Fed is still worried about US economic growth, but less worried than in April, and the Fed still expects inflation to fall back later this year and in 2009, but is now less confident in this outlook. We believe that the tax rebates will provide only a temporary stimulus over the summer and the economy will fail to pick up as hoped. We also believe that current high inflation will be temporary and will eventually converge toward lower core inflation. Core inflation has stayed generally well-behaved despite seven years of rising commodity prices, whilst unemployment at a 4-year high (and likely to trend higher) and manufacturing capacity use at a 3-year low (and set to move lower) should contain wages. But our Fed view has changed. We still expect the next move to be a cut, in contrast to the markets which still expect a rate hike. But we have pushed back the next cut to Q1 2009. Next week is the big week for US data (ISM business sentiment, non-farm payrolls). · Saudi Arabia’s commitment to boost supply is unlikely to bring a major pull-back in oil prices, but it may be enough to stop prices moving much higher. Despite last week’s Jeddah meeting, crude oil prices have held in the $135-140/bl range with Saudi’s 250K bpd increase more than offset by falls in Nigerian output, which is also of higher quality. But the role of speculation has become very high profile, which may curb its future impact, whilst demand destruction has now clearly set in the US and Europe and weaker demand growth looks imminent in the key emerging markets as well - with their economies slowing down and fuel subsidies being reduced (most recently in China). We believe that speculation has played only a small part in this year’s run-up in oil prices and view the market as being fundamentally underpinned by tight supply and demand in the $110-120/bl area. We forecast a topping out of oil prices over the summer, and some pullback, but prices are unlikely to stay down for long. The wildcard is another major supply shock - Iran remains the biggest potential risk. · A European Central Bank rate hike looks virtually guaranteed for next week (on Thursday) but Reserve Bank of Australia rates should stay on hold. The Euro-zone economic slowdown appears to be intensifying with Germany and France deteriorating and the potential long term strugglers - Italy, Portugal, Greece (given their competitiveness problems), Spain and Ireland (given their housing slumps) staying weak. But restrictive labour markets and powerful trade unions have historically made the Euro-zone vulnerable to high headline inflation feeding into higher wages. Therefore, the hawks have won the day and rates should move up 25bps to 4.25%. But one hike rather than a series still looks likely, and we forecast that ECB rates will fall next year. In Australia, domestic demand is slowing down as well but continued positive terms-of-trade effects (cheap consumer goods imports) will likely keep the slowdown moderate and the RBA on inflation alert. Aussie rates have probably peaked but a rate cut is far away - our forecast is not until Q4 2008. An ECB hike should keep EUR/USD in the top end of its recent $1.50-1.60 range. High rates should support the AUD but softer commodity prices are a downside threat. · Equities have had another difficult week. The usual suspects - financials and consumer discretionary - have been leading the way down in major markets but UPS, a good barometer of the global economic outlook, also gave downbeat earnings guidance. The inflation fight has continued to stress emerging equities. We expect that the key countries will succeed in bringing inflation down which, in the end will bring a big equities and bond market rally, but it will stay painful and will take time. India and Taiwan hiked rates this week, Indonesia will likely hike next week. |
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