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Ulster Bank Quarterly Focus on Markets - US
Economy to avoid Recession, ECB Rate Cuts unlikely, Euro to hit new record highs
vs Dollar and Sterling
The following is a summary of the
Ulster Bank Quarterly Focus on
Markets, which was prepared by Simon Barry Senior Economist, Ulster Bank Capital
Markets and published today.
US Economy to Avoid Recession
US services sector to continue to provide
important offset to housing and manufacturing weakness; large-scale monetary and
fiscal stimulus also supportive
ECB Rate Cuts Unlikely
Record inflation overshoot an obstacle to lower
interest rates in the Eurozone
Euro to hit new record highs
vs. dollar and sterling
Recent huge moves highlight how critical it is
for firms to actively manage currency exposure
- Recent indicators on US manufacturing, construction and jobs have raised
concerns about a US recession
- Growth will be weak in the first half of this
year
- Activity in the services sector (80% of the
economy) is holding up well
- While risks have risen the bank expects the US to avoid
a recession, as growth prospects receive support from fiscal and monetary
stimulus
- Simon Barry says that the bank expects a 50bps cut at next week’s Fed meeting
and a further 50bps by April 2008 which would see official rates bottom at 3.25%
- Ulster don’t think that the Fed will need to cut to
below 2.50% as the market currently thinks Growth is slowing in Europe too, but
inflation is the ECB’s main concern Inflation will average over 2.5% in 2008,
the largest overshoot in the ECB’s history
- Lower rates not likely unless growth slows
sharply
- UK housing and services now clearly slowing UK
rates have another 50bps to fall, though Ulster doesn’t share the market’s expectation
for a further 50bps beyond that
- Lower US, UK rates to see dollar and sterling to
fall vs. euro in the next month or two
- Eur/USD to move to new record of $1.50 with $1.55
a distinct possibility; Eur/Stg to also hit a new high of 76.5p
- Recent huge moves highlight how critical it is
for firms to actively manage currency exposure
- Ulster's interest rate views mean there is room for
both the dollar and sterling to rally back later in the year against the euro,
to $1.40 and 73p respectively
- After big moves of late, the scope for further
large falls in long term rates looks limited, so hedging interest rate exposure
on debt at current levels looks attractive
The US, Eurozone and UK economies grew very strongly in Q3 of last year. But
recent indicators point to slower growth since then and a weaker outlook for the
coming year. Despite an easing of year-end tension in money markets, conditions
in the financial markets remain strained, highlighted by recent weakness in the
equity markets.
In the US recent weak data on the jobs front as
well as on the manufacturing and construction sectors has given rise to concerns
that the US economy may have already entered recession. Simon Barry says Ulster does not share this
view. Activity and jobs growth in the service sector (which accounts for 80% of
the economy) remain healthy.
While recession risks have risen, and overall
growth will be weak in the first half of ’08, Ulster thinks that the US can maintain
its impressive resilience to date and avoid recession, helped by 100bps of
further rate cuts from the Fed (including a 50bps move next week) and a package
of fiscal stimulus. Market expectations for rates to be cut by more than 175bps
from current levels look excessive to us.
Eurozone growth is also set to weaken, with
sub-trend growth of around 1.7% on the cards this year. However, inflation
concerns remain the key issue for the ECB, with inflation set to average in
excess of its target of close to but below 2% for the ninth consecutive year in
’08. In fact it will likely average over 2.5% this year – the biggest overshoot
in the ECB’s history. Slightly sub-trend growth may not be enough to get the ECB
to abandon its inflation concerns, though if growth weakened very sharply a cut
later in the year is possible
The UK housing market and services sector have
weakened considerably of late and the Bank of England cut UK rates in December.
Rates there still look too high for a weakening economy, so the bank pencils in another
50bps of cuts in coming months, though with a number of inflation risks on the
horizon, it doesn’t share the market’s expectation for around 100bps of more
easing.
On the fx markets, rate cuts from the Fed and
Bank of England mean the dollar and sterling are likely to remain under pressure
in the next couple of months, with the euro having hit record highs against both
currencies of late. Ulster targets a new high of $1.50 and maybe even $1.55 for Eur/USD
by the end of Q1 while Eur/Stg is also likely to hit a new high of 76.5p. But
rate cut expectations in both the US and UK look overly aggressive in Ulster's view,
so there is scope for both the dollar and sterling to rally back later in the
year against the euro, to $1.40 and 73p respectively. The huge moves in fx
markets in recent months underscore just how vital it is to have an active
approach to currency risk management.
Long-term borrowing costs have fallen very
sharply in the US and UK, and have also declined lately in the Eurozone. Ulster
thinks the scope for further large declines is limited, so while downward
pressure may persist in the short term and it expects long-term rates to be on the
rise as we progress through the year. Current levels therefore look attractive
from a hedging perspective, especially given stubbornly high short-term variable
rates related to the ongoing strains in the money markets.
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