Global Economics - April 07

The global economy continues to be faring well in the face of a downshift in the US. Has the long-awaited decoupling — with the rest of the world untethering itself from the US — finally occurred?
It is premature to conclude that the world has faced a legitimate decoupling test. America’s deceleration has been concentrated in one of the least globalized pieces of
the US economy – homebuilding activity. It takes internal spillovers to drive external cross-border linkages.
America’s downshift will have global implications only if there are spillovers between housing and consumption demand.
Recent IMF research confirms the growing dependence of the rest of the world on the US, warning of a still synchronous global downturn if the US slowdown broadens and deepens. Canada, Mexico, China, and the rest of Asia ex Japan would be especially hard hit.

Market implications. I continue to believe that the American consumer will falter – taking the lead engine of the global growth train off the tracks, with the rest of the world quick to follow. That would be a major shock to financial markets, which are still discounting relatively sanguine prospects for global growth in 2007-08.

Risks. If the US labor market continues to display extraordinary staying power as it did in March, I would be the first to concede that the overly-indebted, saving-short
American consumer will squeak by – and so, too, will the rest of a still-coupled world.

US Economics April 07

The Employment Conundrum

What's New: The mix of growth and inflation has again turned less favorable. And the dichotomy between weak output and firm labor markets raises critical questions about the outlook: Will job and income gains sustain consumer outlays? Has potential output growth declined? If so, will it prolong the whiff of stagflation? And will slowing growth and rising unit costs squeeze profit margins?

Conclusions: Consumer retrenchment is unlikely
although the housing recession is far from over; strong global growth likely will sustain both output and employment. Amid uncertainty about productivity’s trend, we still think inflation has peaked, but inflation risks are rising again. Margin compression implies that profit growth likely will stall in 2007.

Market Implications: This mix likely will reinforce the Fed’s conviction that they must wait patiently for inflation to decline. Rising uncertainty about the outlook and reduced forward-looking guidance from the Fed imply that term and other risk premiums will rise
further, the yield curve will steepen irregularly, and TIPs may outperform.

Risks: The risks for investors are rising with
crosscurrents swirling around the outlook for growth, inflation, profits, and monetary policy. That markets have defied these uncertainties lately does not give us
comfort because we see neither a rapid improvement in growth, a quick decline in inflation, nor relief from the Fed.