The world is slowing
June 24th, 2011
Markets are adjusting to the simple fact that the main economies are all slowing in unison. In China and India higher rates and money controls are beginning to work, slowing the hectic rate of growth. In the USA and the UK the ending of quantitative easing leaves the economies facing the reality of private and public sector debt mountains. People, and in due course governments, will rein in to repay debt. Germany is still doing well, but the logic of Euroland is slowing there too. The ECB has moved to slightly higher rates, whilst the Greek crisis acts as a brake on progress.
We should expect the Obama administration to try to prevent too bad a slowdown in the USA. The President has already pulled a trick with the sale of oil reserves to try to get the oil price down. If it works and is permanent then it does provide a modest stimulus to oil importing countries, and does help reduce the inflationary pressures a little. The Fed has not announced a new quantitative easing policy, but at the very least will be under White House pressure to keep interest rates very low. If anywhere in the west takes strong action to prevent further slowdown it is likely to be the USA. They will not be held back by the possibility that this will weaken the dollar more. The President has an election to win and will do anything he can to improve the immediate economic prospects.
The heavily indebted Euroland countries will be made to accept ever more austerity measures, making it difficult for them to grow their way to success. In the UK there will be a battle on the MPC between the inflation hawks wanting more discipline and the soft economy doves wanting more QE and low rates. For the time being we expect a standoff, with no changes in policy.
This is proving to be a poor year for investors as we feared. Risk assets do not always protect against inflation if activity is weakening. Bonds do not always work when investors expect one day yields will have to go up. It’s a time for caution. The next good news is likely to come from the East, when China reckons she has tightened enough.
