StanChart forecasts 1% Fed base rates by early next year
Posted on 05 June 2008 with no comments from readers
Standard Chartered chief economist Dr Gerald Lyons winged his way through Dubai this morning to see clients and journalists in the Burj Dubai and present his team’s view of the future. StanChart has been pretty accurate in its recent forecasts and is against the consensus in expecting the Fed to cut US interest rates from two to one per cent by early next year.
His message was that the credit crunch has seen the end of the beginning, not the beginning of the end, and that the real economy was weakening at a time that the financial sector was already very fragile. In this environment the Fed is ‘keeping its ammunition ready’ in the shape of another one per cent cut to meet further weakness in financial markets.
In this environment the US dollar is likely to devalue further putting further pressure on the dollar-pegged Gulf currencies. Dr Lyons is emphatic in stating that the region has its monetary policy ‘wrong’ and urgently needs to revalue to head off mounting inflation.
Standard Chartered has compared the UAE economy in particular with Norway and Canada which have similar levels of oil exports and noted that the latter have low inflation rates, but that is down to respective currency appreciations of 76 and 60 per cent. The UAE by contrast, with its fixed peg to the dollar, seems doomed to much higher inflation levels – currently 15-20 per cent according to local business.
Dr Lyons forecast a boom to slump cycle in the medium term if the UAE chose to keep its existing monetary policy. However, oil prices have averaged $102 a barrel in the year to date and are forecast to average $108 for 2008 and $120 for 2009.
In the absence of hard data as to the level of speculation in the oil price StanChart is not sure how long high oil prices will be maintained but ‘at least one to two years’ said Dr Lyons.
He would give the UAE eight out of ten for its macroeconomic management. The plus points would be demographics and diversification, and not surprising the dollar would be the minus element. He said the risk is that the Gulf States will fail to learn the lessons of the credit crunch in the West and expand too rapidly and then face a sudden contraction.
no Comments posted by readers:
He is partially correct.
Today India ceased subsidizing oil for home consumption. This will send home inflation higher, but ultimately reduce demand, and tend to reduce the price of oil.
Reduced domestic demand could impact global commodities downwards.
China is now the only major player, other than the ME, subsidizing oil for home consumption, and even so, mfg output slowed in the last month. Now one month “doth not a summer make”, but if this holds, we are seeing the de-coupling theories go out the window.
Further Chinese subsidies of oil will lead to excessive internal industrial expansion, that will come crashing down later. A controlled slowdown is needed, – something the authorities have failed to achieve, even with substantial bank assets being held centrally, to reduce gearing.
Are we seeing the end of the commodities boom, or a slowdown in demand to levels attainable by the extractive industries, where P/Es will contract, etc, etc? BHP and sundry are all of 10% +/- from their highs. – or will China continue to use its foreign reserves to subsidize oil?
China for its part is in deep discussions to establish a new global currency, since the $ will continue downwards, to probably 58 to 60, but maybe less, from its current 73, bottoming sometime after july 2009. Oil will probably travel down to $90/110 by October 08, absent hurricanes and war mongering, if the Fed stays at 2%. The new currency will probably reflect a basket. Interesting to see if it is gold, or other commodity, backed, and what international body administers the back-office, etc. If the Chinese have any sense of history, and I would bet they do, the rules will be tightly written to exclude all wall street practices, and require members of the basket to maintain high % deposits with the issuing body.
Maybe it’s too early for a global currency, – I can’t see the US giving up its hegemony easily, it would be self destruction. The US would currently fail, totally, without that position. I also don’t see many nations trusting the Fed, should the Fed become involved in any basket machinations.
The time to CONTROL or abolish, the Fed, globally, is when it is at its weakest, in about a year +/- from now. But that will be the time that the Fed makes an over-sight power grab, or seeks to consolidate a past power grab, in order to correct errors made in the past. Errors ironically that are entirely the fault of past Fed policies.
The destruction of demand caused by credit contraction/implosion is working its way through the system. More bank/financial blow ups are coming, overnight rates are increasing again. SWFs would be foolish to step in until the last moment, having been burned several times already.
Will we see a slow motion downward spiral, like japan, or will MORE global inflation be implemented to try to avoid it.A reduction of 1% in the $ would not achieve the level of global inflation needed to avoid the marching deflation
How does the world return to balanced progress after this?
It must, somehow, be a coordinated massive, protracted, gentle unwind, but the political will for that does not exist. Neither does the forum. The incentive to cheat would be enormous. In fact, quite the opposite of coordination would be the norm. Beggar my neighbour rules, laced with protectionism and banned/restrictions, on exports.
Oh well, interesting times.
Also interesting is how precious metals would behave in a global downturn/recession/depression.
I agree that the Fed will be obliged to cut interest rates further, and probably sooner rather than later. The housing slump in the US is getting worse. The latest data from Housing Wire.com shows that mortgage defaults, on both Fixed Rate Mortgages and Adjustable Rate Mortgages, are increasing amongst “prime” borrowers faster than “sub-prime” borrowers. In other words, delinquencies and foreclosures are spreading up the affluence chain to middle class and upper middle class Americans. The 2 worst hit areas are California and Florida. California drives the US economy.
Secondly, Fitch Ratings stated on 5 June 2008 that it is much more pessimistic on the outlook for the mortgage insurance sector in the US. It downgraded the rating of 2 mortgage insurance companies, leaving both on “rating watch negative”. This means further downgrades are possible. I would not be surprised if one or more mortgage insurers failed, after heavy exposure to the exotic Collateralized Debt Obligations. It’s now apparent that these CDOs were the subject of very dubious, overly-optimistic credit ratings.
Thirdly, business insolvencies in the US, particularly for SMEs, have increased. Interest rates may have fallen, but the contraction in credit has affected their ability to obtain financing.
Fourthly, as Nouriel Roubini points out in the RGE Monitor, Wall Street’s commissions on financial deals has fallen dramatically as hedge funds and institutional investors lick their wounds and turn risk-averse. Wall Street’s clout in Washington is well known, so expect at least one more interest rate cut to tempt investors to do deals.
Given the systemic issues in the housing, financial and business sectors, the Fed will once again ignore inflation and cut rates.
And speaking of inflation in Asia, here in Hong Kong, our Dollar is pegged to the US Dollar, in the same way as Gulf currencies are pegged to it. Inflation in Hong Kong is moving upwards, although not at the same rate as in the Gulf. By the way, didn’t you find it slightly odd that Henry Paulson was just in the Gulf persuading them to keep the dollar link? Effectively, it drives up inflation there and, in the face of a devaluing dollar, gives them less for their oil even as prices go up. My suspicion is that he was attempting to stall the momentum for a common Gulf currency in an attempt to maintain US economic hegemony on the denomination of commodity prices.
I am a lawyer in Hong Kong and was looking for an informative financial blog on from a UAE perspective which took into account US ecomomic and business data. I came across yours and was very impressed with it. I also write a blog that relates US business and economic news to cash flow issues affecting SMEs in the US. May I please have your permission to put a link to your blog on my blog?
Yes happy to link to your blog. This is a very complex situation and for the first time in my lifetime I find my Oxford late 70s economics very useful!