FYI | Apr 19 2006
Last December, Barclays believed most forecasters were being too pessimistic about the potential for global economic growth. Now forecasts have overshot even Barclays’ expectations, and Barclays has also revised up – from 4.3% to 4.8%.
The anticipation of stronger growth leads to expectations of considerably more central bank policy tightening, says Barclays. Again, forecasters were previously on the side of no tightening, and yet further rate hikes have already occurred. Barclays now expects the Fed rate to hit 5.5% long before the year is out (consensus has been a halt at 5.0% for some time now), with the ECB heading to 3.25% by year-end and the BOJ to 0.25% with a bullet.
Such tightening forecasts should put a bit of a clamp on market performance but, on the contrary, yield curves have steepened, commodity prices have surged, stock markets have surged, M&A activity is rampant, credit growth has accelerated and credit spreads have remained tight. Barclays suggests the reason for such enthusiasm – in the face of stretched valuations – is that global tightening is simply keeping pace with solid economic performance. This means central banks are not actually trying to stymie such growth.
In the US in particular, manufacturing and exports have been boosted by robust global growth, the housing slump has not been dramatic, and the consumer, says Barclays, has been holding up quite well. Increases to commodity prices threaten core inflation which is another reason to expect further tightening.
Besides monetary policy, Barclays notes the only other restraining factor on the US economy has been oil prices. These should help to assist the Fed in its policy of restraint by countering inflation effects with natural tightening conditions of input costs. Now that oil appears to have broken out of its nine month US$60-70/bbl range, this could well be significant.
Furthermore, Barclays suggests "The improvement in global growth prospects is indicative of an important shift in the global dynamic that will increasingly push bond yields higher, thus helping the Fed in its efforts to restrain US growth and inflation pressures".
Interest rates have been kept low for nearly a decade in order to drag the global economy back from the Asian currency crisis of 1997. The US has thus suffered a persistent widening of its current account deficit and a flow of capital into US bond markets. This is what has kept bond rates down in the face of short-end tightening – the world’s "excess savings". As economic prospects outside the US significantly improve, says Barclays, this previous dynamic is fading.
The evidence is there – Japan has come in from the cold, Europe is waking up, China is back to stimulating domestic demand in order to address its trade surplus, commodity countries are spending, and emerging countries are beginning to spend as well.
Barclays expects global current account imbalances to begin to retreat. This means less capital inflow to the US. (This prediction was made before the February figures were released – see FYI: US Dollar Fails To Respond To Positive News, 19/04/06 – although one presumes this would not affect Barclays’ wider view). This means a weaker US dollar (which is very likely – see same article).
Barclay’s tip for global investment is: pro-cyclical asset allocation favouring commodities and stocks over bonds for a while yet. Base metals will enjoy continuing global demand, and oil will continue to be affected by geopolitical issues. Barclays is not, however, a precious metal bull as many others are, believing current prices reflect speculation more than fundamentals.
Higher oil prices and commodity demand will also drive inflation. The US is the ideal candidate, says Barclays, to eventually suffer a moderation in growth as a result – probably at the end of 2006 or early 2007.