From the beach 2008
Fri 18 Jan 2008 by Gareth Kiernan.

A raft of weak indicators over the last month has intensified market fears that the American economy is now in, or the verge of, a recession.

  • The number of homeowners falling behind on their mortgage payments continues to rise.
  • The ISM manufacturing index fell to its lowest level in almost five years.
  • Oil prices climbed to US$100/bl.
  • The unemployment rate surged to 5%, the biggest monthly jump since the 2001 recession.

Further downward revisions in growth forecasts are in store.   A US recession will push economic growth below 2%pa for the first time since 2002.   And with homeowner default rates still ballooning five months after the "credit crunch" began, hopes that the US economy will quickly pull out of its current nosedive would seem slim.  It could be late 2008 before we can start contemplating recovery in America – even allowing for the programme of substantial interest rate cuts being undertaken by the Federal Reserve.

US household debt is now equal to 138% of disposable income, up from 113% five years ago.   The high indebtedness of American households is a trend that has been replicated across other English-speaking countries.   In New Zealand, debt servicing costs for households as a percentage of income are now 73% higher than the average level of the 1990s.   These figures provide a clear message that we should not assume New Zealand households will be immune to financial stresses.

The US recession of 2008 will be a different beast to the 2001 version.   This time around, consumer confidence and spending growth will come under significant pressure from high debt-servicing costs, a collapsing housing market, increasing unemployment, climbing energy and food prices, and rising import prices as a result of the weak greenback.

Weaker aggregate demand across America will have flow-on effects for Canada, Japan, China, and India, which all send more than 20%of their exports to the US.   Global economic growth in 2008 is likely to slip below 3%pa for the first time in five years.

The extent of the global slowdown also has implications for commodity prices.   Current futures pricing suggests that oil prices will stabilise at around US$88/bl by March 2010.   At this stage, however, expectations for most hard commodity prices such as gold and timber remain elevated.   A more pronounced global slowdown would pull commodity prices back from their current highs, thereby relieving some of the worldwide inflationary pressures.   But don’t expect a complete collapse in commodity prices – the expansion of the global economy over the last five years has been the biggest since Japan went belly-up in 1990, implying that the capacity pressures currently being felt worldwide will not disappear overnight.

The dairy bonanza

Fonterra’s latest forecast payout for the current season of $6.80/kgms implies that the average dairy farmer’s income will be $280,000 higher than the previous year.   The total payout to dairy farmers looks set to be more than $3bn (or 1.8% of GDP) higher than for the 2006/07 season.

Dairy dollars will provide a shot in the arm for the New Zealand economy at some stage, but don’t expect to see a great deal of the cash flooding through the provinces much before the end of 2008.  Farmers are traditionally conservative creatures – paying off some debt, possibly buying a new vehicle or some other capital equipment, maybe a bit of renovation to the farmhouse.   The rest of the money is likely to be held until well into next season, as farmers wait for certainty about where the pay out is headed to from here.

Even if the dairy payout in the 2008/09 season dropped as low as $5.50/kgms, the average dairy farmer’s income would still be up $120,000 on 2006/07 levels.   Certainly if the payout were to hold at $7/kgms, a further surge in rural land prices could be expected heading into2009, along with a renewed acceleration in conversion to dairy farms (along with plenty of associated construction and investment activity).

Higher dairy payouts may not be an instant saviour for the New Zealand economy, but they do provide a geographic and demographic focus for retailers and other businesses looking to insulate themselves against a slowdown in consumer spending growth over the next year.  West Coast, Waikato, Taranaki, Southland, and Northland are the most dairy-intensive regional economies, and shape as the areas most likely to benefit in the first instance.   Canterbury, Manawatu-Wanganui, and Bay of Plenty also have a significant dairy presence, but the positive effects of spending will take longer to appear in the other, less dairy-intensive, regions.

The grey ghost strikes again

Despite the somewhat shaky state of the global economy, prospects for monetary policy in New Zealand this year look tighter rather than looser – at least for the next six months.

  • The effective mortgage rate is currently around 8.4%, but will getup to 8.9% by the end of this year as homeowners continue to be faced with re-fixing their borrowing at considerably higher rates.   As recently as late 2003, the effective mortgage rate was down at 6.9%.
  • Divergent directions in monetary settings between here and overseas will maintain upward pressure on the New Zealand dollar.
  • Firms’ ability or willingness to undertake investment may also be stunted.   Having said that, investment spending picked up throughout 2007, and investment intentions are still around average levels.

We see little chance of the Reserve Bank getting a firm grip on inflation this year, despite tight monetary settings.  Inflation is set to hold between 3% and 3.5%pa for much of this year.

In November, we predicted house price falls of 7.2% over the year to March 2009.   That forecast remains on track, as rising debt-servicing costs and high levels of indebtedness lead to an increased number of forced sales by property owners that have overextended themselves.

But this is not a wholesale collapse for the housing market.   The labour market is set to remain relatively tight this year.   The lift in dairy incomes will provide some support for provincial property prices.   And an intensifying buzz ahead of the election about tax cuts will also help keep pessimism at bay.

And the highest bidder is:

The 2008 election will be one of shameless vote-buying from both major parties.   Labour’s 2005 success in picking up key segments with well-targeted policies appealing to voter self-interest (eg the removal of interest on student loans) is likely to see them pursue a similar strategy this time around.   National will be forced to play the same game, although their usage of the surplus is likely to be largely centred on personal income tax cuts.   National also has the advantage of having a head start over Labour in the polls, along with a perception that the current government has grown increasingly tired and out of touch with the public.

We expect National to be the main party in government at the end of this year.   National’s policy approach is likely to be slightly more favourable for businesses and the New Zealand economy’s potential growth rate.   But overall, policy over the forthcoming year will be typified by political expediency rather than solid economic rationale.   In other words, the policy environment will be a continuation of what we’ve seen over the last 3-5 years.

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