World Economy is not in bad shape

publication date: Nov 8, 2007

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author/source: (November 2007)

Giles Keating

Head of Global Research, Credit Suisse

Asian economies are very strong while the US and Europe are experiencing a slowdown due to the US credit crisis. Despite this, Giles Keating, Head of Global Research for Credit Suisse Private Bank, believes the global economy seems in reasonable balance and that the risk of recession is not high. With this in mind, we ask Giles Keating for his current take on the World Economy.

The world economy is not in bad shape at the moment despite the credit crisis. The latest data suggests there is a slowdown underway in the US and in Europe as well, which is a bit more marked than expected, partly because US housing is so weak. However, China and the rest of Asia are still very strong, which helps limit the danger that the slowdowns in Europe and America turn into recession. The strength of corporate sector finances is also a good backstop to growth, because it tends to keep job creation going.

Is Switzerland also affected by this slowdown?

Well, Switzerland can't be immune because it is a big exporter, but overall I think the Swiss economy is looking pretty healthy. The likelihood is therefore that Switzerland will see a period of slightly slower growth, but the risk of it coming near recession is low. Perhaps within nine months, or in even less time, we will see things accelerating again.

You mentioned Asian growth. How long can this growth be maintained in the wake of the US slowdown?

It looks, at the moment, as though Asia will see smaller rather than larger effects from the US slowdown, provided that an outright recession is avoided. One reason is that Asia has become somewhat less dependent on US growth, as trade within the region has risen. Moreover, some components of domestic demand in Asia are growing very rapidly, notably fixed investment in China.

And how is that ongoing Asian boom impacting other regions?

The impact is profound. Throughout Asia, whether India, China or some of the smaller economies in the region, we are really seeing some of these countries becoming the power houses of the world economy. They are providing a lot of less expensive goods, which helps to keep the lid on inflation. They are also consuming a lot of raw materials and energy, which is pushing oil prices to high levels, as well as metals and food. That, of course, is bad for inflation and a problem that the rest of the world has to cope with. So, the growth is double-edged.

How should investors react to those rising commodities prices?

Commodities have been, and still are, in a long-term bull market, which could probably go on for a magnitude of another three to four years. Or perhaps even a bit longer. Of course there will be cyclical swings within that time and over the next two or three months, we might see a slightly slower period as a result of one of those swings. As a strategic matter, we do believe investors should have exposure to commodities. However, we certainly recommend that they do so through specialist funds, and we advise that they choose those funds pretty carefully.

Is there an inflation risk here? And do you expect the Fed will announce further rate cuts?
At the moment, it looks as though the inflation risk is not great enough to prevent the Fed from cutting again if it chooses to do so. The Fed and the other central banks must keep an eye on inflation, not least because of those energy and raw materials prices. Currently, those high resource costs don't seem to be feeding into other parts of inflation and this leaves the Fed free to cut rates again if they need to in order to keep the economy moving forward. The balance of likelihood on this can change on a daily basis but the key point is that so far, the benign inflation leaves the Fed some room for manoeuvre.

The markets have been rallying. Is this a trend that can last?

The equity markets have done very well since the correction in August. Since then, we have seen a strong rally and many markets are breaking new highs. I think that is due in part to the fact that for sustainable reasons, the valuations are still not particularly high and because the economic growth outlook, as we discussed, doesn't look bad.. In particular, emerging market equities have rallied as well as companies in the developed world that are exposed to the emerging markets. We think that can go on a bit more. It won't be a straight line, of course, but we think that valuations in some markets, notably Brazil, Russia and the Middle East, are still attractive and that the growth stories are still there. In addition, there is still liquidity there and a lot of investor money, and that combination can drive prices up further.

Looking to the US, its trade deficit has been falling. What does this reflect?

The decline in the trade deficit is an interesting development because people have been very worried about it for many years. What is happening now is that with the US economy growing slower at a time when the rest of the world – especially Asia – is growing rapidly, a good combination has been created for bringing the deficit down. The slower growth of the US consumer keeps the import growth down, and that strong growth abroad helps to boost exports. And the dollar's weakness is also a bonus because it helps to make US production attractive and competitive, and that further keeps the trade deficit down.

Do you think that the dollar weakness is set to continue?

We’ve had a big fall in the dollar against the Euro over the last couple of months, all the way from the mid 1.30s right into the mid-1.40s, and a similar move against the swiss franc. Some further but smaller bouts of dollar weakness are still possible over the next few months but I think they are unlikely to be as large as the moves we’ve just seen. Against the yen, as we get into next year, the dollar could start to weaken along with some of the other Asian currencies. So, for the time being it’s a picture of the dollar staying pretty soft, however, the risk of having it collapsing isn't that high.

If the dollar is going to stay weak, is gold a good alternative?

I think gold is beginning to look a little bit expensive. As far as one can measure, it is at a high-level by historic standards when adjusted for inflation. We have been seeing ranges around 800 dollars per troy ounce, and those ranges are more of a holding area rather than a buying one. We do think that some of the other precious metals, such as silver and platinum, can also offer significant value. Those investors looking at precious metals out of concern about the dollar should place less of a focus on gold and more of a focus on some of those other precious metals.

What is your forecast for the bond market?

Quite a question mark remains for longer-dated bonds in the 10-year area and we are not really advising investors to go there. Certainly as we look forward several months, and as the economic outlook becomes clearer, we think there might be some upward pressure on some of those longer yields. However, for the shorter-dated maturities of two to four years in many of the major markets we feel reasonably comfortable with investors having a kind of core holding. Again, we don't think by any means that investors should aggressively hold fixed income rather than equities. We think it is equities that will outperform, but it is good to have an element of fixed income in a portfolio as a balance and that is the maturity range to have, focused on good quality recommended credits.

Can you sum up what all this means for investors?

It is still a healthy environment for investors. We believe that equity portfolios can do pretty well, but we believe the credit problems have not gone away, with some credit areas having seen an improvement while others have continued to worsen. It is a world in which the global economy is starting to see an unwinding of some earlier imbalances, like the US trade deficit, and while that is good in some ways it also creates upheaval. The dangers include the risk of inflation from that very rapid growth in Asia, or the risk of the US or European economies slowing down too much, but at this moment we think that those risks are containable. This leads us to this healthy view for the equity markets, although volatility has risen and may well rise further, and we are cautious on the dollar and not so excited by the fixed-income world at the moment.

Biography

Giles B. Keating is Head of Global Research at Credit Suisse. Giles received his B.A. in Philosophy, Politics and Economics from St. Catherine's College, Oxford University and his M.Sc. in Mathematical Economics and Econometrics from the London School of Economics.
In May 2003, Giles returned to CSFB after a year leave of absence working on a book at the London School of Economics. Previously, he was Chief Economist and Global Head of Fixed Income Research and Economics, managing a global team that covered both developed and emerging markets. He has recently been awarded ‘Volunteer of the Year’ at this year’s prestigious Lord Mayor of London’s Dragon Awards. Giles is the driving force behind VoiceMail4All, a project managed by St. Mungo’s, offering free 0208 voicemail numbers to homeless people. He was presented with his award by Lord Mayor John Stuttard at an exclusive banquet on Wednesday 10th October to celebrate the efforts of the great and the good throughout London to put something back into their community.

This interview appears courtesy of Michele Bodner, Credit Suisse Publications. www.credit-suisse.com/infocus