Global Markets Weekly - 4th August 2008

• Despite talk of recession US GDP growth accelerated in the second quarter of the year.
  Over recent months it has been hard to escape talk of various economies going into recession, yet even in the US, the country at the vanguard of the global slowdown, growth has remained positive. On the face of it, data for the second quarter of this year suggest the US economy was again able to dodge the bullet: annualised GDP growth in the second quarter was 1.9%, an acceleration from the 0.9% print for the first quarter. The details of these numbers are unfortunately less reassuring, but also hold some unexpected implications for investors that it are worth exploring.

• Consumer spending growth remains historically low, although did benefit from tax rebates.
  passed US consumption spending growth remained historically low, contributing just 1% to overall growth, relative to its average contribution over the last decade of 2.2%. However, this does represent an improvement over the previous two quarters. Despite surveys indicating that consumer confidence is at generational lows we estimate that US consumers managed to spend around a third of the $80bn tax rebate package that began being distributed in May and will complete in August.
  
  The rise is gasoline prices over the quarter (from $3.28 per gallon to $4.08) was not sufficient to swallow the entire tax rebate, as some had feared, but will have blunted its effect. The tax rebate effect will not carry over into the second half of the year and so the expectation must be that consumption spending will slow again.

• Net export growth is now the strongest since 1980.
  A more important source of growth during the first half of the year has been net exports (export growth minus import growth). Exports grew 9.2% during the second quarter and imports fell 6.6% - both relatively extreme changes encouraged by the weakening dollar and rising oil prices that led to a 2.7% drop in gasoline demand. Net exports are now making the largest contribution to GDP growth since 1980 – a period when like today, consumption spending growth had moved below its 10-year average and stayed there for several quarters.

• A weakening labour market will add further downward pressure to US household spending.
  Slower consumption spending and (relatively) higher demand growth in the rest of the world is the ‘rebalancing of global growth’ that so many commentators and investors have been waiting for. Despite the rise in the oil price, the US current account deficit has already shrunk to 5% of GDP from a peak of 6.5%. The lagged impact of existing dollar weakness and evidence of a shift in energy consumption behaviour suggests that this trend will continue. Consumption spending, and the import growth associated with it, is also likely to slow as the labour market weakens. Labour market data for July, released last week, showed that the US continues to shed jobs, but still at a relatively modest pace that is likely to pick-up in the second half of the year.

• Taken together, this creates the economic conditions neccesary for a stronger dollar.
  The trade-weighted US dollar has been declining for six years and is now 23% lower than in 2002, reaching levels that back in the early 1980s and 1990s marked troughs of the dollar cycle. The pattern of US growth described above - slower consumption growth and export outperformance - is the same macroeconomic backdrop that arrested the three dollar depreciations witnessed since the end of the Bretton Woods system of exchange rates in the early 1970s. Interest rate differentials that favour Europe and emerging market economies will keep some downward pressure on the US dollar in the near term. Looking over a longer time period, the growth imbalances that led to the last six years of dollar decline are starting to dissipate. To far-sighted investors, especially those based in European currencies, this looks like an opportunity to buy US dollar assets.

Indices, Interest rates and Inflation

	Close 01-Aug-08	1 Week%	1 Month%	3 Months%	YTD %
FTSE ALL Share	2,723	0.0	-2.1	-12.1	-17.1
FTSE 100	5,355	0.0	-2.3	-12.0	-17.1
S&P 500	1,260	0.2	-1.9	-10.6	-14.2
Nasdaq Composite	2,311	2.0	0.3	-6.8	-12.9
DJ Stoxx (Europe)	311	0.0	-1.3	-15.1	-25.1
Nikkei 225	13,095	-1.5	-2.7	-4.9	-14.5
Hang Seng	22,863	0.5	3.4	-11.2	-17.8

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Sep-08 Forecast	Dec-08  Forecast	Current	Next Date
US (Fed Funds)	2.00	2.00	2.00	5.0	05-Aug
UK (Base rate)	5.00	5.00	5.00	3.8	07-Aug
Euro-zone (Repo Rate)	4.25	4.50	4.75	4.0	07-Aug
Japan (Call rate)	0.50	0.50	0.50	2.0	19-Aug

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