FYI | Aug 28 2007
By Chris Shaw
While trading over the past week or so suggests investors have largely shrugged off the recent correction on the back of sub-prime concerns in the US credit market Commonwealth Bank chief economist Michael Blythe suggests caution is still required as the crisis is far from over.
Blythe suggests the short-term impact of the market fallout has been a crisis of confidence, which effectively saw the demand side of the market dry up and the disappearance of private equity from the market is a perfect example of this effect. The result was an imbalance in relation to the supply side of the market, which caused the sharp adjustment in prices across a range of assets.
While a recovery in confidence has been seen in the past week or so Blythe suggests the experts are far less confident, a view reflected by the recent actions of the US Federal Reserve. Its decision to cut the discount rate by 50 basis points means its concerns for the economy are widening as it is now no longer focussing primarily on inflation as the major threat to the economy.
In Blythe’s view the cut in the discount rate is likely to be followed by a cut in official interest rates when the Fed meets in September, an action he expects will influence other central banks around the world. There are signs this is already the case as the Bank of Japan recently held off lifting rates, helped in its decision by somewhat disappointing growth data.
This expected change in policy will complicate the outlook for the global economy in Blythe’s view so it is important to look at some recent trends for guidance. Internationally he points to the fact the global economic outlook remains solid regardless of how things play out in the US, a consequence of the rest of the world having de-coupled itself somewhat from the US in recent years.
While this is good news for the global economy Blythe is equally positive on the domestic outlook, arguing the best defence against global concerns is a strong domestic economy and here the picture is relatively bright.
Currently strong sectors of the Australian economy such as capital expenditure, public spending and the labour market are expected to remain strong, while Blythe expects the weaker sections of the economy such as housing, exports and the rural sector to also improve in coming months.
Inflation pressures will remain, but as Blythe notes these demand driven pressures are eased somewhat when the supply side also grows and again he sees this as the case. There also remains a lot of flexibility in terms of local policy, as Blythe points out there is significant scope for the Reserve Bank of Australia (RBA) to cut interest rates if data justifies such action. Fiscal policy measures could also be implemented if needed.
As a result he sees scope for the Australian economy to remain in good shape, as assuming everything plays out according to forecasts the positive fundamentals should again reassert themselves.
Blythe forecasts domestic GDP to finish the year at close to 4%, a level he expects will be maintained through to the end of FY09 given improving household income levels should maintain consumer spending, which is the potential weak link in the economy.
Assuming the current situation plays out in line with expectations, traders should note Blythe expects both government bonds and the Australian dollar to move higher in coming months.
