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Global Chartbook

February 2008

Wed, Feb 13 2008, 11:08 GMT
by Jay Bryson

Wachovia

Executive Summary

Global Growth Should Slow to Trend in 2008

Global real GDP growth averaged 5% per annum between 2004 and 2007, the strongest four-year period of growth in decades. Rising inflation rates led to a tightening of macroeconomic policies over the past few years, which caused some deceleration in global economic activity in 2007. In addition, dislocations in credit markets caused by the subprime mortgage debacle in the United States appear to have weighed on growth rates in many economies at the end of 2007. Looking forward, we project that global growth will fall a bit below its long-run average in 2008. Growth rates in many major economies may be sluggish this year. However, economic activity in many developing countries, which are less affected by dislocations in credit markets than their major economy counterparts, should remain rather solid.

The marked downturn in housing has weighed on U.S. real GDP growth over the past two years. Outside of housing, however, most sectors of the U.S. economy continue to grow, albeit at rates that clearly have slowed. Although we project that U.S. real GDP growth will be anemic in the first half of 2008, we are hopeful that the economy can avoid outright recession. Solid growth in the rest of the world should continue to drive U.S. export growth, and the strong financial health of the U.S. business sector should limit layoffs. The Fed will likely cut rates further in the first half of 2008.

The pace of economic activity in Europe slowed over the course of 2007 due in part to lagged effects from previous monetary tightening and currency appreciation. That said, monetary conditions in the Euro-zone are not very restrictive at present. The European Central Bank continues to carp about inflationary risks, but we expect CPI inflation will trend lower over the next quarter or so as GDP growth slows. Therefore, we expect the ECB will remain on hold for the next few months, before easing policy this summer. Across the Channel, we look for the Bank of England, which has cut its policy rate by 50 basis points since early December, to continue easing policy. In contrast to the Euro-zone, British monetary policy is restrictive at present, and, in our view, the Bank will need to ease further to help head off recession.

On the other side of the world, economic growth in most Asian countries remains rather strong, due in part to financial conditions that generally remain accommodative. Moreover, robust growth in China, which is being fueled by very rapid increases in capital spending, is helping to propel growth in most other Asian countries as well as in resource-rich Latin countries. Inflation, which was long dormant in many Asian economies, is starting to become an issue again. Therefore, many Asian central banks likely will tighten monetary policy further in the months ahead. In addition, Asian governments likely will allow their currencies to strengthen at a faster pace, because currency appreciation helps to dampen inflationary pressures.

Dollar Turnaround in Sight?

Speaking of currencies, the U.S. dollar has followed a downward trend against most major currencies for nearly six years. Indeed, the greenback dropped to all-time or multi-year lows versus many major currencies at the end of last year. There are a number of reasons for the dollar’s decline. For starters, the large U.S. current account deficit has exerted downward pressure on the greenback. In addition, interest rate differentials have moved against the United States over the past year or so, which has reduced the relative attractiveness of U.S. assets to foreign investors. More recently, dislocations in credit markets have caused new issuance of structured fixed income products to plummet. Foreign purchases of structured products have totaled hundreds of billions of dollars over the past few years, and reduced issuance has given foreign investors fewer U.S. securities to purchase.

Looking forward, we look for the dollar to consolidate versus most European currencies in the first half of 2008. Although the greenback could set new lows in the near term, we believe that the dollar’s downside vis-à-vis most European currencies is rather limited. Looking into the second half of the year, we forecast that the greenback will begin to strengthen against most European currencies as the Fed’s easing cycle comes to an end. If, as we project, the U.S. economy narrowly avoids recession, then investors will begin to anticipate Fed tightening in 2009. In contrast, the Bank of England and the European Central Bank will still be cutting rates in mid-year. We project that the greenback will strengthen further versus most European currencies in 2009 as the FOMC begins to tighten policy anew.

However, our forecast calls for the dollar to depreciate further against most Asian currencies. Not only do most countries in Asia incur current account surpluses, which tend to put upward pressure on currencies, but central banks in the region likely will tighten policy further due to rising inflationary pressures. In addition, Asian governments will have an incentive to let their currencies strengthen, because currency appreciation helps to constrain inflation.

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Published on  Wed, Feb 13 2008, 11:16 GMT

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