FYI | Sep 13 2006
By Chris Shaw
HSBC has joined the side of the bears with respect to the outlook for the US economy, suggesting higher energy prices and the recent increases in interest rates have changed conditions and with the housing market seemingly in a virtual freefall the combination is enough to threaten its rate of economic growth.
The bank’s concern is not centred on the corporate sector, where it sees the recent solid performance continuing given the outlook for profits is still good and companies are enjoying strong cash flows. This has not flowed through into powering the economy though, as investment levels are still weak and more money is being paid out via dividends and buybacks than is being channelled into new growth options.
Further complicating the picture is in recent years there has also been an impact from higher commodity prices, the bank pointing out US corporations have responded to increasing energy prices by cutting their costs, which includes wages. As globalisation makes labour more mobile wages growth in mature markets such as the US has not risen at rates comparable to previous periods, leaving consumers worse off in income terms with only the increase in housing prices allowing domestic consumption to stay strong.
This means it has been the household sector driving the economy as consumers have taken advantage of rising home prices to spend rather than save. Now though the bank sees the outlook for the household sector as dangerous, as the combined impact of tighter monetary and fiscal policy suggests the recent fall in housing prices may continue, so prompting a reversal of the wealth effect of the strong gains in housing prices in recent years.
The current housing cycle has also been far stronger for longer than previous cycles, as housing indicators have risen 130-200% compared to normal gains of 100-150%. Usually the boom cycle is followed by declines in the indicators of 40-60%, the bank suggesting this leaves plenty of room for further weakness in the housing sector.
Supporting the bank’s view is its estimation housing in the US remains significantly overvalued, with valuations in bubble regions such as Florida and Washington DC as much as 35-40% above justifiable levels.
It discounts the ability of the US to achieve the soft landing enjoyed by both the Australian and the UK economies, which managed to ride out housing downturns as the sector’s weakness was offset by solid real incomes and ongoing strength in the US economy. In contrast the bank notes income gains in the US have been poor, so stability of household demand is more questionable as growth in real disposable income slows and there is no supporting global growth engine to bail out the US economy.
The bank notes a stabilisation in energy costs would limit the pain being inflicted on the household sector to some extent, but only if it was proven to be sustained as HSBC suggests households take some time to adjust their spending habits to the prevailing conditions. But if the current weakness in oil prices proves temporary and prices again spike higher, the acceptance by households of permanently higher costs would see spending in other areas fall, which is clearly not bullish for the economy as a whole.
Assuming the trend in housing of the past few years is now beginning to reverse itself the bank has cut its growth outlook in the US, with its forecast for 2007 now standing at 1.9% from 2.6% previously and compared to a trend growth rate of 3.25%. This might be a somewhat misleading figure though, as on the bank’s new estimates growth in the final quarter next year is likely to be around 1.3%, which brings to centre stage the threat of a recession.
Consumption growth is now expected to be 2.1% next year, down from 3.2% in 2006, while the bank is forecasting residential investment to decline by 13.8% next year, compared to a decline of around 2% this year.
To counter such a threat the bank expects the Federal Reserve will begin cutting rates next year and is targeting an official interest rate of 4.0% by the end of next year compared to 5.25% now, with potential for further cuts into 2008. This is unlikely to prove supportive for the US dollar, which the bank suggests will fall to at least 140 again the euro (compared to around 127 now) and 100 against the yen (from 117 now).