The US GSE turmoil has global implications, because of the large agency holdings by foreign central banks. Our view is that most foreign central banks will likely avoid investing more in US agencies in the months ahead, but will increase their buying of US Treasuries instead. This uncomfortable substitution is only possible because the US still commands the most liquid and deep financial markets in the world and, in times of global turmoil, the dollar is still the currency to hold, especially for EM (emerging market) central banks. Also, the fact that the world is still experiencing aggregate excess savings should help fill US financing needs. However, over the long run, we believe that the US – both the public and private sectors – will need to fundamentally reform and restructure in order to continue to attract foreign capital. According to latest US Treasury data (see Preliminary Annual Reports on US Holdings of Foreign Assets and Foreign Holdings of US Assets, August 29, 2008), foreigners demonstrated a huge appetite for USD assets in 2007. Total foreign holdings of long-term USD securities increased from US$7.8 trillion in 2006 to US$9.8 trillion in 2007, with US$1.3 trillion of this annual increase from increased foreign holdings of US long-term debt securities, including US Treasuries, agencies, agency ABS and corporate bonds. Foreigners are dominant in some of these markets.
Stephen Roach, Head Economist, Morgan Stanley
Weekly Bank Research Center 09-08-08
Foreign Holdings of US Agencies and the Dollar
Stephen Roach, Head Economist, Morgan Stanley
The US GSE turmoil has global implications, because of the large agency holdings by foreign central banks. Our view is that most foreign central banks will likely avoid investing more in US agencies in the months ahead, but will increase their buying of US Treasuries instead. This uncomfortable substitution is only possible because the US still commands the most liquid and deep financial markets in the world and, in times of global turmoil, the dollar is still the currency to hold, especially for EM (emerging market) central banks. Also, the fact that the world is still experiencing aggregate excess savings should help fill US financing needs. However, over the long run, we believe that the US – both the public and private sectors – will need to fundamentally reform and restructure in order to continue to attract foreign capital. According to latest US Treasury data (see Preliminary Annual Reports on US Holdings of Foreign Assets and Foreign Holdings of US Assets, August 29, 2008), foreigners demonstrated a huge appetite for USD assets in 2007. Total foreign holdings of long-term USD securities increased from US$7.8 trillion in 2006 to US$9.8 trillion in 2007, with US$1.3 trillion of this annual increase from increased foreign holdings of US long-term debt securities, including US Treasuries, agencies, agency ABS and corporate bonds. Foreigners are dominant in some of these markets.
Tax Package Won't Last Forever
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Domestic demand stateside will remain weak in the coming quarters. Private consumption has been propped up by the government.s tax rebates, but as these payments are a one-off, their positive effect will not last forever. Although consumers have held back and not blown the whole cheque in one go, the outcome will still be a net negative contribution to private consumption growth from late Q3 this year. The coming week brings retail sales figures for August. We were a little surprised to see auto sales increase quite significantly in August, but we expect the underlying trend in retail sales to be weak.
Lower Inflation Will Remove Any Lingering Doubts About Fed Policy
E. Silvia, Ph.D. Chief Economist, Wachovia
Even though we continue to hear a little noise from the more hawkish members of the Federal Open Market Committee, there is little doubt the Fed remains firmly on hold. The Fed is not about to begin to raise interest rates with the unemployment rate rising and economy teetering on the edge of recession. Moreover, inflation is set to moderate significantly in coming months, with falling oil prices paving the way for outright declines in the most widely followed inflation gauges. From a more fundamental perspective, inflation looks set to moderate significantly over the coming year. Productivity growth has ramped up and unit costs have moderated. Nonfarm productivity increased 3.4 percent over the past year, while unit labor costs rose just 0.6 percent. Moreover, weaker economic growth around the globe should help bolster the dollar and further reverse the run-up in commodity prices. While higher interest rates are off the table, more has to happen before the Fed can consider lowering rates. The Fed eased much more than the economic data alone would have justified earlier this year in order to combat the credit crunch and has less room to maneuver today that they would like. We will need to see much more economic weakness or another credit event in order for the Fed to move. We doubt that will happen before the presidential election. Slower economic growth overseas will likely have a less immediate effect on curbing inflation there. Wages and prices are rising rapidly overseas and that makes for a more intractable inflation problem. As a result, overseas rates will likely come down very gradually and too slow to keep their economies out of recession.
Inflation Concerns Prevent Rate Cuts in the U.K. and Euro-Zone
Steve Chan, Economist, TD Bank Financial Group
Despite an economy flirting dangerously with a recession, the Bank of England held interest rates steady yesterday, as inflation – at 4.4% – is more than double the target rate, and upside risks remain. Still, with oil prices well off their July highs, we feel that the deteriorating economy will soon outweigh inflation concerns and lead to rate cuts in the U.K. – perhaps even by next month. Similarly, the European Central Bank (ECB) stood pat yesterday in spite of a second quarter contraction in economic growth and the bank’s subsequent lowering of GDP growth forecasts for 2008 and 2009. ECB President Trichet cited upside risks to inflation as the motivation behind the decision, as price stability is the bank’s primary objective. While the upper bounds of the bank’s inflation forecast for this year and next did not increase, we still feel that high inflation levels will prevent the ECB from beginning an easing cycle before March of 2009.
High Global Inflation Has Hit Economic Growth
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
With second quarter gdp data now available for the main economies, this might be a good time to look at how global economic growth has performed so far in 2008. Chart a shows that Q2 growth is currently much lower than in the year earlier in all of the major economies. Of course, the world economy has been hit by two major shocks in the last 12 months, the bursting of the credit bubble and a big rise in global inflation. Although the two effects are difficult to separate - both are at work to reduce the pace of economic activity - the sharp rise in price inflation appears to have more obviously hit household incomes, raised firms’ costs and led to weaker growth. Tighter lending conditions have intensified the slowdown. As a result of this, consensus forecasts for economic growth have been lowered sharply for this year and next, see charts b and c, mirroring the rise in forecasts of price inflation. We have been continually revising our forecasts for the global economy to reflect the worsening trend of recent economic data. Indeed, a scenario we carried out in May suggested that the biggest risk facing the world economy was higher than expected inflation, partly driven by rising oil and food prices resulting from fast growth in the emerging markets and loose monetary policy in the developed countries in the last five years. Unfortunately, events have moved closer to this more negative scenario for economic growth than in our central forecast at the time. However, it is still likely that the world economy will avoid recession, with the US showing tentative signs of also avoiding recession, but growth in the UK, Japan and the eurozone continues to weaken more than expected earlier in the year.
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