Economic Triple Threat

I came across this in the Edge, and found it as a very interesting read on the global economy:

History tells us that September and October have not been good months for investors. The 1929 Wall Street Crash erupted on Oct 24, causing world markets to plunge by more than 30% and tipping the global economy into the Great Depression. In 1987, the US market crashed on Oct 19, triggering a chain reaction across the globe.

This year, as October approaches, the outlook seems rather glum. The silver lining is that no one is expecting a global recession at this juncture. Already, there has been a spate of negative news that has roiled financial markets worldwide.

First, we have the US subprime mortgage crisis threatening US growth and tipping it into recession. Meanwhile, the Japanese economy contracted in the second quarter, sparking concerns that it, too, may slide into a recession. China isn't doing that well either — its inflation hit a 10-year high in July at 5.6% while its economy continues to expand at a sizzling pace. To make things even more complex, crude oil prices are again rising, hitting a new high of US$80 a barrel last Thursday and heading for the next level of US$90 a barrel. Will the worst come to pass?

The US subprime mortgage crisis, whose roots go back to 2005, became full-blown this year. The problem, even as we speak, is still unravelling, and the danger is that it could spill over to the rest of the US economy and tip it into a recession — if not this year, then the next. The possibility of a recession in the US became more real last week when the US Labour Department reported that non-farm payrolls fell in August for the first time in four years. There was a loss of 4,000 jobs, down from 68,000 job increases the month before. Now, all eyes are on what the US Federal Reserve Board will do when it meets on Tuesday to decide on interest rates. The consensus view is that with the latest downturn in the labour market, the Fed will have no choice but to cut the benchmark overnight federal fund rate (FFR) by at least 25 basis points, from 5.25% to 5%, to ensure a soft landing for the economy.

"A 25 basis-point cut in the Fed Funds policy rate on Sept 18 is all but a done deal," DBS Research wrote in its report, adding that it expects another 25 basis-point cut in October. A recession in the US will spell trouble for Asia, whose main export destination is the US. While there is a growing view that China will take up some of the slack, a recession in the US will still hurt Asia. At this point in time, however, most economists are still betting that a recession won't happen. Projections are for US growth to remain flat at around 2% in 2007 before rising to about 2.5-2.8% in 2008. CIMB Investment Research, in a report, wrote: "At this juncture, we think the (US) economy will be able to ride through this period of uncertainty and volatility without heading into recession. "While problems in the housing and financial markets have hurt consumer confidence, we draw comfort that corporate balance sheets are healthy, non-residential investments are positive while job and income growth are still supporting consumer spending."

Last week, Japan said its gross domestic product (GDP) contracted by 1.2% year on year in the second quarter of this year, compared with a contraction of 0.3% in the previous quarter. The drag on growth was a decline in business investment. Now, economists say Japan will not be raising its key interest rate any time soon. Japan's sharper-than-expected economic contraction did not help sentiment any, as it came at a time when investors were already jittery about the possibility of the US sliding into recession. It was not helped either by the political uncertainties resulting from the resignation of Prime Minister Shinzo Abe. Still, economists aren't too worried about the latest statistics indicating a recession for the Japanese economy, noting that machinery orders in July surged 17%, its highest in four years. Economists say that while business outlays underperformed, export growth is still decent, and they expect a moderate recovery in consumer spending, which should keep the economy from contracting further. The projection is for the Japanese economy to expand by about 2% this year and the next.

The news flow out of China isn't very good either. Last week, China said its inflation rate hit a 10-year high of 5.6% year on year in July and that despite attempts to cool growth, its GDP still ran its fastest pace ever, expanding at a scorching pace of 11.9% in the second quarter. Not surprisingly, investors are asking how long the Chinese economy can grow at this breakneck speed without crash landing. China has raised its one-year deposit and lending rates six times since 2006 while the yuan has appreciated 10% since it was unpegged in July 2005.

The kick in the teeth, though, came from rising crude oil prices. Last week, crude oil prices finally surpassed US$80 a barrel. On Thursday, light sweet crude for October delivery closed at US$80.09 on the New York Mercantile Exchange. Now, market pundits are seeing the next target at US$90 a barrel. Oil prices were pushed higher by three major factors — a sharper-than-expected drop in US oil inventories, a lower-than-expected increase in oil production by Opec and the hurricane season in the Gulf of Mexico and Louisiana coasts, where the refineries are located. A conundrum arises for policymakers if crude oil prices continue to climb. For one, it will fuel inflation, and thus limit the room for the US Fed to cut rates at a time when it may need to do so.

The upshot of all this is that the global economy is heading for some uncertain times. So, we should brace ourselves.

So we have the triple threat. As the author said we are heading for some uncertain times. We better heed the warning and be prepared...