Global Economic Snapshot

The International Energy Agency is preparing to release a report that will sharply downgrade forecasts of future oil supplies, mainly due to restrictions on capacity investment by oil exporting governments. It also projected growth in global demand of 1.2% this year as reductions in the U.S. and Europe are more than offset by strong demand growth in India, China, and the Middle East. News of the report helped push oil over $135 a barrel in Thursday trading and is likely to fuel argument that price increases are a product of long term structural change and not short term financial speculation.

Snapshot asks, can OPEC be pushed to invest in more than token capacity expansion?

Wall Street Journal - Energy Watchdog Warns Of Oil-Production Crunch
Bloomberg.com - IEA Plans to Lower Oil Supply Forecast in Next Annual Report
New York Times - New Fears on Long-Term Global Oil Supplies
Bloomberg.com - IEA Is Studying Output Depletion at Oilfields to Gauge Supply
International Herald Tribune - International Energy Agency urges OPEC to produce more oil

Federal Reserve Vice Chairman Donald Kohn says conditions in the credit markets are improving. Equities prices have rallied, spreads on high-grade corporate bonds have fallen considerably, and firms have not had trouble raising funds in credit markets. These positive signs are the result of the Fed's efforts to boost liquidity, ability of financial institutions to raise capital, and better than expected economic data.

Despite some positive signs, credit conditions are not optimal. Many investors remain skeptical of credit quality and the securitization market of mortgages has fallen dramatically. Because the market for securitized loans has deteriorated, banks cannot bundle and sell loans and other assets. As credit conditions deteriorate and the risk of default increases, financial institutions have had to de-leverage their balance sheets.

Snapshot asks, are credit markets improving or have we only begun to see a drawn out process of de-leveraging?

Federal Reserve Bank of New York - May You Live in Interesting Times: The Sequel
Don Kohn - May 20th Speech
Financial Times - Fears of Prolonged Credit Crisis Hit Wall Street

Food and energy prices are rising and inputs for producers grow more expensive by the day, putting enormous pressure on central bankers to keep inflation low. This is pressure is particularly acute for Mervyn King and Jean Claude Trichet, the heads of the Bank of England and European Central Bank, who promise their governments to keep inflation around 2%. With no sign of a break in energy prices, the Bernanke Fed has also been warned by former Fed Chairman Paul Volker to keep inflation low. Volker said last week that there is a resemblance between today and the 1970s and that the Fed already introduced enough liquidity into the market.

Snapshot asks, are central bankers recklessly abandoning their inflation targets?

Martin Wolf - Britain Must not cut loose its anchor
Financial Times - Higher inflation stems from official neglect
Paul Volker - Act now to avoid inflation
Janet Yellen Federal Reserve Bank of San Francisco - Combination of Risks

A 0.2% overall decline in April retail sales masked divergent patterns in U.S. consumer spending. While auto spending decreased by 2.8%, spending on non-auto goods actually rose by 0.5%, a larger than expected increase. With consumer spending accounting for over 70% of the U.S. economy, some see this resiliency as a sign the economy may be closer to recovery than previously thought. Others say it's a statistical blip and expect continued contraction throughout 2008 as gas prices and inflation increase.

Snapshot asks, will high gas prices and weak auto sales further drag down consumers in 2008?

A proposal by Gordon Brown's government to up the taxes paid by resident foreigners and demand greater transparency in their offshore dealings has many fearing an exodus of London's international financiers. This comes at a time when increasing numbers of businesses in London are also moving their headquarters to countries with lower taxes. Layoffs by banks in the wake of the subprime crisis are further damaging the City's reputation as a vibrant financial center. A loss of foreign residents and international business would be devastating for a city that has emerged as New York's greatest rival for global preeminence.

Snapshot asks, could New York reclaim the top spot if London falls?

For the first part of 2008, the Chinese have increased the pace of yuan revaluation, but in doing so they may have augmented inflation, the very problem they are trying to prevent. Speculators poured funds into China (some believe as much as $200bn) during the first quarter of 2008 on the assumption that the undervalued yuan will appreciate further. The increased pace of appreciation during the first quarter only gave speculators more incentive to sneak cash in China's back door. The resulting growth in the monetary base has contributed to Chinese inflation. As a policy response some have argued China should do a one-off revaluation of the currency anywhere from fifteen to forty percent. Unsurprisingly, the Chinese authorities have not taken this risk.

Snapshot asks, what will be the pace of future yuan revaluation and will it stoke or reduce inflationary pressure?

Some are questioning whether the US is in a recession. Job losses last week were less than expected at -20,000. Many expected between -75,000 and -80,000. The stock market has rallied and the Dow Jones Industrial Average broke through the 13,000 mark last week. The Federal Reserve cut interest rates by 25bp but two members of the FOMC dissented. Richard Fisher, president of the Dallas Fed, and Charles Plosser, president of the Philadelphia Fed, argued there was no need for a cut. Despite a blip of positive news, the prospects for the U.S. housing market and American consumer are likely to continue to drag on the economy. For a graphic representation of how damaged the US housing market is, see Ben S. Bernanke's Mortgage Delinquencies and Foreclosures.

Snapshot asks, if this recession is led by falling housing prices and damaged consumers, when will it be worst?

The Conference Board's consumer confidence index fell again to 62.3 from 65.9 in March. The index was dragged down by the present situation index, which measures consumers' assessment of current economic conditions. Housing data also weighed on the economic outlook. Home prices from the largest urban areas around the country fell 13.6% in February from prices a year earlier. Given the slowing consumer and the rapidly declining housing prices, economists fear a "negative feedback loop," in which consumers, hurt by deteriorating house prices and poor consumer credit conditions, buy less and damage corporate profits.

Snapshot asks, will the struggling consumer keep the U.S. in a prolonged recession?

The euro may be overvalued, but don't expect it to fall anytime soon. Rising commodity prices have pushed eurozone inflation to a sixteen year high at 3.6% and the European Central Bank remains committed to inflation targeting monetary policy. The ECB recently pushed back against the Bank of England and IMF who claim there is room for rate cuts. On the other side of the Atlantic, recession fears led to aggressive interest rate cuts in the United States. The weak dollar has caused a rise in the price of imports increasing inflation, but also made exports cheaper and more attractive to foreign consumers. The earnings reports from internationally exposed companies in the first quarter of 2008 cited strong foreign demand and better than expected earnings.

Snapshot asks, where will the euro be at the end of 2008?

Since November, sovereign wealth funds have injected $41 billion of a total of $105 billion into struggling financial institutions. Since the purchases, the weighted average of those investments is down 40%. Many sovereign wealth funds are somewhat protected by buying mandatory convertible bonds, which pay large dividends to their holders before paying out to those with common stock. Still, sovereign funds were hasty in their investments and have spent the last couple months licking their wounds.

Snapshot asks, when will sovereign wealth funds move back into financials?

Reuters - Gulf Arabs put brakes on buying spree, await bargains
Wall Street Journal - SWF Losses
Bloomberg - Bear Stearns's Ruin Will Shake Sovereign Funds
IMF (Box 1.2) - Global Financial Stability Report