Thursday June 9, 2005 - 13:50:14 GMT
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US and European de-industrialisation
The evidence on G7 economic trends, bond yields and commodity prices has been generally contradictory over the past few weeks with mixed signals on the strength of growth. Lower bond yields in major markets and evidence of weaker manufacturing activity have been contradicted by firm commodity prices. One possible explanation is that the North American and European economies are now losing market share at a faster pace in the global manufacturing economy.
This pattern would help explain the contradiction of apparently slowing growth and still-high commodity prices with global output not weakening, but being switched to emerging markets in Asia and Eastern Europe. The dominance of the US Treasury market may also be distorting bond yields lower.
If this pattern is taking hold, there will be the risk of a deteriorating trade performances within the Euro-zone and Americas. This would be particularly important within the US given that the current account deficit is already around 6.0% of GDP. A renewed widening of the US trade deficit would tend to undermine dollar confidence. In the medium term, there would also be pressure for dollar depreciation against Asian currencies and quite possibly emerging markets in general. It would also imply that the Euro would struggle to take advantage of any renewed US dollar vulnerability.
The latest industrial data from the Euro-zone and US economies has been disappointing. The Euro-zone PMI index for the manufacturing index remained below the 50.0 level for the second successive month in May and the UK index also continued to deteriorate with the CIPS index for manufacturing weakening to 47.3, the lowest reading since March 2003. A level below the 50.0 level indicates that the manufacturing sector is contracting. The US index remained above the 50.0 level, but the ISM index for the manufacturing sector still fell to a 2-year low. The Canadian manufacturing sector has also weakened over the past few weeks, but the Japanese indicators have improved slightly.
The data on the face of it points to a slowdown in the global economy. Global PMI indices have not, however, recorded a serious deterioration which suggests the difficulties may be confined more locally. There have, for example, been well-publicised difficulties in the US auto sector.
The evidence from other markets is mixed and generally points to a confusing picture. Oil prices have pushed back to near US$ 55/pb before weakening slightly and commodity prices remain at high levels. Commodity prices may of course be pushed higher by speculation rather than underlying physical demand for commodities, but the evidence suggests that metal demand is still firm.
Bond yields in the major economies have continued to weaken. US Treasury yields have fallen to below 4.0% despite the series of Federal Reserve interest rate increases while German yields have fallen to near 3.1%. The bond market performance suggests that markets are expecting a sharp economic slowdown within the next few months.
Services sector indicators have also signalled some slowdown in growth, but have held relatively firm. Monetary and fiscal policies are still expansionary or at worst neutral even with the US rate increases. The overall monetary and fiscal stance should not be weakening the manufacturing sectors seriously at this stage of the cycle.
Priced out of markets
It is, therefore, possible that the manufacturing sectors in the Euro-zone and North American economies are being priced out of global markets. There have already been particular concerns over the Italian economy which has struggled to strengthen productivity and lower unit costs since the Euro was introduced in 1999. The Italian economy as a whole is now back into recession.
The evidence may now suggest that power-house emerging-market manufacturers such as China and India are grabbing market share at the expense of the US and Europe. Industrial relocation to lower-cost manufacturing plants has been an important feature throughout the past few years and will inevitably continue. There will, however, now be concern that the process is accelerating due in part to currency distortions. The deterioration in the US and Euro-zone manufacturing performance in comparison with Japan may suggest that Asia is gaining ground. There is also tentative evidence that the new EU members from Eastern Europe are starting to erode manufacturing capacity in the ‘old’ European economies.
Bonds may be missing shifting growth
With Asian central banks buying Treasury bonds and global markets keying off US bonds, the strength in other parts of the global economy may not be picked up by the markets which would help explain why US bond yields are lower than expected even though the US Federal Reserve has been tightening policy.
The resistance to currency gains in emerging economies may also be contributing to the switching of industrial capacity abroad as real exchange rates in Asia are too low. In this context, the Chinese exchange rate will inevitably be a very important focus, although wider regional trends will also be important. The overall evidence, therefore, suggests that Asian currencies will probably need to strengthen significantly in the medium term.
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