A raft of weak indicators over the lastmonth has intensified market fears that the American economy is now in, or theverge of, a recession.
- The number of homeowners falling behind on their mortgage paymentscontinues to rise.
- The ISM manufacturing index fell to its lowest level in almost fiveyears.
- Oil prices climbed to US$100/bl.
- The unemployment rate surged to 5%, the biggest monthly jump sincethe 2001 recession.
Further downward revisions in growthforecasts are in store. A US recession will push economic growth below 2%pafor the first time since 2002. And with homeowner default rates stillballooning five months after the "credit crunch" began, hopes thatthe 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 â€“ even allowing for the programme of substantial interest rate cuts beingundertaken by the Federal Reserve.
US household debtis now equal to 138% of disposable income, up from 113% five years ago. Thehigh indebtedness of American households is a trend that has been replicatedacross other English-speaking countries. In New Zealand, debt servicing costsfor households as a percentage of income are now 73% higher than the averagelevel of the 1990s. These figures provide a clear message that we should notassume New Zealand households will be immune to financial stresses.
The US recession of 2008 will be adifferent beast to the 2001 version. This time around, consumer confidence andspending growth will come under significant pressure from high debt-servicingcosts, a collapsing housing market, increasing unemployment, climbing energyand 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 slipbelow 3%pa for the first time in five years.
The extent of the global slowdown alsohas implications for commodity prices. Current futures pricing suggests thatoil 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 remainelevated. A more pronounced global slowdown would pull commodity prices backfrom their current highs, thereby relieving some of the worldwide inflationarypressures. But don’t expect a complete collapse in commodity prices â€“ theexpansion of the global economy over the last five years has been the biggestsince Japan went belly-up in 1990, implying that the capacity pressurescurrently being felt worldwide will not disappear overnight.
The dairy bonanza
Fonterra’s latest forecast payout for thecurrent season of $6.80/kgms implies that the average dairy farmer’s incomewill be $280,000 higher than the previous year. The total payout to dairyfarmers looks set to be more than $3bn (or 1.8% of GDP) higher than for the2006/07 season.
Dairy dollars will provide a shot in thearm for the New Zealand economy at some stage, but don’t expect to see a greatdeal of the cash flooding through the provinces much before the end of 2008. Farmers are traditionally conservative creatures â€“ paying off some debt, possiblybuying a new vehicle or some other capital equipment, maybe a bit of renovationto the farmhouse. The rest of the money is likely to be held until well intonext season, as farmers wait for certainty about where the payout is headed tofrom here.
Even if the dairy payout in the 2008/09season dropped as low as $5.50/kgms, the average dairy farmer’s income wouldstill be up $120,000 on 2006/07 levels. Certainly if the payout were to holdat $7/kgms, a further surge in rural land prices could be expected heading into2009, along with a renewed acceleration in conversion to dairy farms (alongwith plenty of associated construction and investment activity).
Higher dairy payouts may not be aninstant saviour for the New Zealand economy, but they do provide a geographicand demographic focus for retailers and other businesses looking to insulatethemselves against a slowdown in consumer spending growth over the next year. West Coast, Waikato, Taranaki, Southland, and Northland are the mostdairy-intensive regional economies, and shape as the areas most likely tobenefit in the first instance. Canterbury, Manawatu-Wanganui, and Bay of Plenty also have a significant dairy presence, but the positive effects of spendingwill take longer to appear in the other, less dairy-intensive, regions.
The grey ghost strikes again
Despite the somewhat shaky state of theglobal economy, prospects for monetary policy in New Zealand this year looktighter rather than looser â€“ 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 withre-fixing their borrowing at considerably higher rates. As recently as late2003, the effective mortgage rate was down at 6.9%.
- Divergent directions in monetary settings between here and overseaswill maintain upward pressure on the New Zealand dollar.
- Firms’ ability or willingness to undertake investment may also bestunted. Having said that, investment spending picked up throughout 2007, andinvestment intentions are still around average levels.
We see little chance of the Reserve Bankgetting 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 pricefalls of 7.2% over the year to March 2009. That forecast remains on track, asrising debt-servicing costs and high levels of indebtedness lead to anincreased number of forced sales by property owners that have overextendedthemselves.
But this is not a wholesale collapse forthe housing market. The labour market is set to remain relatively tight thisyear. The lift in dairy incomes will provide some support for provincialproperty prices. And an intensifying buzz ahead of the election about tax cutswill also help keep pessimism at bay.
And the highest bidder isâ€¦
The 2008 election will be one ofshameless vote-buying from both major parties. Labour’s 2005 success inpicking up key segments with well-targeted policies appealing to voterself-interest (eg the removal of interest on student loans) is likely to seethem pursue a similar strategy this time around. National will be forced toplay the same game, although their usage of the surplus is likely to be largelycentred on personal income tax cuts. National also has the advantage of havinga head start over Labour in the polls, along with a perception that the currentgovernment has grown increasingly tired and out of touch with the public.
We expect National to be the main partyin government at the end of this year. National’s policy approach is likely tobe slightly more favourable for businesses and the New Zealand economy’spotential growth rate. But overall, policy over the forthcoming year will be typifiedby political expediency rather than solid economic rationale. In other words,the policy environment will be a continuation of what we’ve seen over the last3-5 years.