I personally don’t think so. To start, the latest data for the OECD leading indicator series continue to point to a firming trend. The six monthly percentage change on this indicator shows a steady gain. At the disaggregated level, the OECD series show gains on a 6 monthly comparison basis for Euroland, Japan, and even Switzerland.
The indication for the US is less buoyant, however, with that leading indicator showing little movement — in terms of an up or down trend — over the past year. Leading indicator series are, of course, strongly influenced by trends in interest rates.
Given the 300 basis point rise in Fed funds since the middle of last year, it is reasonable to predict some slowdown in the pace of US growth. Indeed, there is increasing evidence of weakness on the consumer side.
While a sharp drop in confidence was to be expected in the immediate aftermath of Hurricane Katrina, given that gas prices were at that time well over $3.00 a gallon in US gas stations, the modest recovery in confidence over the last couple of months has been a disappointment. After all, gas prices have fallen quite sharply in recent weeks and most reports on the labor market indicated a decent level of job creation.
On the industrial side, things look rather better in the US. Recent readings for the ISM (Institute for Supply Management) survey are quite strong, especially on the manufacturing side. Moreover, the decline in inventory, as indicated by the third quarter US GDP data, points to a need to replenish stocks which should boost industrial output in the months ahead. European surveys also indicate a firming of the industrial sector over the last six months or so.
In the context of such trends, interest rate expectations hardened markedly over the period from mid-September to mid-November. Thus, the 4-week US Treasury bill has moved from around 3.4 percent toward the end of September to close to 3.9 percent recently. The rise in Europe rate expectations has been even more evident. Whereas the 12-month Euribor rate was around 2.2 percent at the start if September, it is now around 2.75 percent.
Such interest rate movements were also supported by the hawkish comments of monetary officials. In October, a number of FOMC members gave speeches to the effect that inflation, while not out of control, was at the upper edge of the Fed’s comfort zone. In November, ECB chief Trichet indicated that rate rises were inevitable. Indeed, the ECB increased its rate by half-a-percentage point early this month.
Interest rate sentiment has subsequently flipped with the release of the minutes of the FOMC meeting on Nov. 1. These minutes raised the possibility of an end to US monetary tightening. Members noted: “Policy setting would need to be increasingly sensitive to incoming economic data. Some members cautioned that risks of going too far with the tightening process could also eventually emerge”.
How would this affect investors’ strategy? I continue to believe that investment strategy should be based on the assumption that there will be several rate rises, both in the US and in Europe over the next six-to-nine months. The Japanese authorities, however, could remain super-cautious in raising rates, and I do not anticipate any meaningful tightening until 2007.
In the near term, investors should expect equities and other risk assets to perform well. Bonds are recovering from an “oversold” situation and any near-term interest rate rises by either the Fed or the ECB, have already been well flagged.
Finally, the year-end is often a relative good time for markets; enough people seem to believe in a year-end rally so that expectations have a self-fulfilling aspect.