Australia | Sep 21 2006
By Chris Shaw
As part of its range of services PIMCO, a specialist fixed income manager with assets under management of more than US$615bn, provides a quarterly update on its view of the global economy. The group, through managing director Paul McCulley, this week released its latest update.
The first point McCulley made was looking back to forecasts made in March the group’s expectation was for a soft landing for the global economy. Essentially that view remains intact, though it now expects a greater slowing in the US economy, which has implications for the rest of the world.
Its new growth forecast for the US economy is a range of 2.0-2.5%, down from its March forecast of 2.75-3.25%. At the same time, it has lifted its inflation estimate to a range of 1.75-2.25% from 1.5-2.0% six months ago. The change reflects the group’s view the US housing sector is now in a recession, the slowing leading to increases in inventory that in turn are slowing production, which is a negative for the economy’s growth overall.
Where it remains cautious is on its view of US consumption, as according to McCulley it is difficult to determine just how much consumer activity can be attributed directly to the wealth impact from the gains in house prices in recent years. Other factors must also be considered, such as fuel prices and the potential the recent run in gasoline prices to around US$3.00 per gallon may have also led to people cutting back on spending. As a result, there remains the potential for some upside to its growth estimates in the US, as with gasoline prices now sliding back towards US$2.00 per gallon consumption may again pick up as the fall in price effectively acts as a tax cut.
While the market is now beginning to talk about when the US Federal Reserve may cut interest rates McCulley suggests such a move is likely some time off, as inflation continues to be problem as it remains above the Fed’s target range. Evidence inflation is returning to that target range may take some time, so PIMCO’s view is the Fed is likely to be patient and hold rates steady for longer than some in the market currently expect.
In terms of whether China’s growth run is coming to a close PIMCO’s view is no, the growth story has significantly further to run. There are likely to be hiccups along the way as McCulley notes there is clear signs of some excessive investment in some sectors of the Chinese economy, but longer-term the outlook is positive.
This is also positive for Japan, as he notes the strength in the Chinese economy and its growing demand for Japanese goods means it is now less reliant on the US economy than has been the case historically. He also expects the Bank of Japan will take a careful approach to the normalisation of interest rates, an outcome likely to be good for confidence in the economy as a whole. Despite this PIMCO has cut its forecasts for Japanese growth to a range of 1.75-2.25% against 2.5-3.0% in March, while its inflation outlook is unchanged at 0.25-0.75%.
Europe remains an interesting case in the group’s view, as it sees the potential for a deceleration in growth in the region as the current strength is based on high levels of business confidence in Germany and high consumer confidence elsewhere in Europe, both of which it expects will moderate. Driving this process will be ongoing moves to both lift interest rates and to slow credit and monetary growth, McCulley suggesting the European Central Bank actually runs the risk of hurting the economy by lifting rates to achieve its inflation target rather than doing so because the economic outlook implies such a move is required.
He expects both Europe and Japan to lift rates once or twice more, so with no further increases expected in the US this implies weakness for the US dollar. There has been no change to the group’s growth forecasts for Europe of 1.5-2.0%, though it has lifted its inflation forecast to 1.75-2.25% compared to 1.5-2.0% previously.
In the same way China is helping the Japanese economy PIMCO sees the commodities boom as helping emerging economies, the group suggesting these are now reasonably well placed given domestic fundamentals have and are continuing to improve and most emerging nations are enjoying improved terms of trade. This leaves them less exposed to the US economy than is traditionally the case.
Although the group has not changed its position in terms of what it considers the most likely outlook for the global economy, it points out in terms of investment strategy there are still no easy decisions. As an example it notes downturns in the housing sector in the US are usually a by-product of either restrictive conditions brought about by Federal Reserve action or a recession, but this is not really the case this time. As a result it remains cautious, which is probably not a bad approach for the rest of us given if pressed it sees the risk to its forecast being to the downside.