HBOS Australia Weekly Economic and Financial Market Snapshot
Dow stages mini-recovery but equity markets still skittish, while
Global debt markets remain unsettled by sub-prime fallout, as
US corporate bond risk premia rise further, while
Spreads at shorter end also rising, although not as high as when Fed delivered its first emergency funds rate cut on 18 September
US house prices still falling from coast to coast, so
Sharp pull-back in consumption in lead up to Christmas cannot be ruled out, and
Neither can recession in the world s largest economy
Local debt market still factoring in at least one more cash rate increase, although
Concerns about sub-prime contagion have rightly dampened - but not extinguished - expectations of multiple increases
The Dow grabbed back some its recent losses last night, but continues to wane more than wax as the drip feed of news about sub-prime losses weighs on the outlook for the broader US economy.
And if the world s largest economy is about to slide into recession, its housing market will take it there. Not of its own accord, but if falling house prices trigger a sharp slowing private consumption (which comprises 70 per cent of US GDP) as Christmas approaches.
The increasingly closely followed S&P Case-Shiller composite index of house prices in 20 American cities fell for a 14th month on the trot in September. Moreover, prices fell in all 20 household name cities, from New York to LA and everywhere in between in September. In the year to September, prices rose in only five of the cities in the index, while the composite national index fell by 4.5 per cent. Two Floridian cities led the decline in the year to September - Tampa down by 11.1 per cent and Miami by spot on 10 per cent. New York is down by 3.6 per cent, while the city of angels is down by 7 per cent.
While the US housing market looks for a floor that may still be some way down there, its debt market remains unsettled, characterised by rising risk premium spreads on corporate debt instruments. The spread on Bloomberg B rated composite 10-year bond yields over equivalent risk-free (ie US
government) bonds has breached 500 basis points, after dipping as low as 260 in the middle of the year. That was too low for sure, and maybe even 500 is not way too high, but the speed of the increase since sub-prime fallout intensified and the lack of visibility towards the summit collectively indicate that sub-prime contagion within the financial economy is still very much in play - the bigger question is whether it is about to contaminate the real economy.
No such weakness in house prices in Australia, but sub-prime contagion nevertheless has the capacity to obviate the need for another local cash rate increase, but unless that happens by February, if the December quarter CPI is anything like either of the last two (ie quarterly underlying inflation of 0.9 per cent), the RBA will have little or no option but to raise the cash rate again at its first Board meeting of 2008 on the 5th of February.
The local bank bill futures market has scaled back some of its aggressive expectations of multiple cash rate increases, although it is still very much factoring in at least one more increase.
The Australian dollar remains under pressure even as the unwinding of the yen carry trade stops to draw breath, because the US dollar s slide is at least for now also in abeyance, although the big dollar s recovery is nothing that hasn t been seen several times before in the last couple of years, only to give way to new historical lows month in month out.
The Australian dollar de-coupled from commodity prices in the wake of the Asian currency crisis of 1997, and has had mixed success in latching back onto them a few times. But while the on again off again marriage is not without its problems, if commodity prices were to fall precipitously, they will probably take the Australian dollar with them, although even that depends on what happens to interest rate differentials, a key component of which is the yen carry trade.
Base metals only account for 16 per cent of the RBA s benchmark index of commodity prices, but they nevertheless are a key barometer of commodity prices in general, because concerns about sub-prime contagion to the broader global economy, including China, are often cited, rightly or wrongly, as the key reason for falling base metal prices. Australia s economic growth probably doesn t grind to a halt until sub-prime contagion triggers falling iron ore and coal prices (which together comprise a chunky one third of the RBA index), but the slide in base metal prices nevertheless takes on more significant proportions almost by the week.
And the gold price (9.4 per cent of the RBA index) is a mirror image of the oil price - at least when both are denominated in US dollars - so if the latter falls markedly - if only, I hear you say as you plan the Christmas driving holiday - gold will likely go with it as well. Not that last night s $3 plus drop in the oil price is necessarily any portent to where the oil price is going, but central banks grappling with sub-prime contagion and latent inflationary pressures will take any relief they can get from near $US100 a barrel oil prices.
(See attached file: WEEKLYSNAPSHOT28NOVEMBER2007.pdf)
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Alan Langford
Chief Economist
HBOS Australia
Level 8
BankWest Tower
108 St. Georges Tce, Perth
Western Australia 6000
phone: +61 08 9449 6354
fax: +61 08 9449 6266
e-mail: alan.langford@hbosa.com.au
The information contained in this publication is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this publication without first obtaining specific professional advice. To the extent permitted by law, HBOS Australia Pty Ltd, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this publication.
