The churning global caldron sets our scene

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By Cees Bruggemans

The global picture is being hugely unsettled by two massive disturbances, namely the still intensifying US financial emergency and the perceptual shift underway in global commodity markets inducing price weakness.

The consequences should become reflected in asset values, inflation, growth, interest rates and currencies over the coming year.

The story so far this year is a loss of global growth momentum due to the playout of the financial crises in rich countries, and the commodity price shocks inducing high inflation, interest rate responses and some growth loss in especially emerging regions.

After mid-year 2008, the global financial crises seem to have intensified yet further as these phenomena entered their second year, with more growth loss predicted for the US, Europe, Japan and the smaller satellite economies.

In contrast, the commodity price boom abruptly reversed direction from mid-July, on the assumption that the earlier conditions had indeed punctured global demand growth, with more growth unwinding still to be expected from the intense financial crises and the higher interest rates being imposed throughout the emerging universe.

From being overhyped, and loaded up with speculators, many of them highly respectable (pension funds), the perception shift favoured dumping commodities. In less than two months, the oil price has lost 40% of its value, with possible more to go before things stabilize.

This reverse commodity price shock is now dramatically revising global inflation prospects downwards for next year. The leading central banks in any case expect economic weakness to erode their inflation back towards acceptable limits near 2%. And emerging central banks face imploding inflation rates if food prices also remain well off their recent peaks.

In South Africa’s case, the re-weighting of inflation indexes gives a further downward twist to inflation, even if rentals prove to be the new ‘high’ inflation item.

Uncertainty rages about exchange rates. Withdrawal from certain markets (commodities) and regions (emerging) are creating return flows of homebound capital, favouring a firming of Dollar and Yen, even as the stern ECB policy stance erodes European growth prospects and the Euro.

As countries start to cut interest rates in response to the receding inflation threat and the gathering loss of growth momentum, especially emerging currencies could come under further downward pressure.

This has already been the case in Kiwi and Aussie.

Even at just over 8:$, the Rand has so far given way only modestly in response to the changing global scene, being mostly a firming Dollar phenomenon. This is also reflected in the Rand’s relative stability against the Euro near 11.50:E. This shows our still well funded balance of payments despite a huge current account deficit in excess of 7% of GDP.

Still, we will also want to reduce nominal interest rates once the inflation danger recedes sufficiently to intimidate even second-round effects and growth sacrifice becomes ever more visible.

But we may trade-off something in that exchange, with a yet weaker Rand possibly following in response to lower interest rates, thereby neutralizing some of the downward inflation and interest rate potential.

Hopefully nothing drastic will eventuate, allowing next year to evolve a prime interest rate of 13% relative to 6% CPI inflation, with the Rand in 7.50-9.50:$ territory, and the growth cycle bottoming beyond mid-2009.

Thereafter a new business cycle expansion may commence, probably reminiscent of the slow 1999-2002 takeoff rather than meteoric 2003-2004.

As to political uncertainty about policy direction, next year will hopefully bring greater clarity, and this too should become reflected in our make-up.

Source: Cees Bruggemans, FNB, September 17, 2008.


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