A World of Trouble
By Rick MacDonald
The international situation has taken a turn for the worse. While the July 7-8 meeting of the Group of Seven (G7) -- the leading industrial nations -- highlighted hopes that a second-half recovery in the U.S. will provide a lift to the struggling global economy later in the year, recent developments in Asia, Latin America, and Europe suggest just the opposite.
Indeed, the recent rapid deterioration in the global environment is now a threat to derail U.S. recovery hopes pinned on the fiscal and monetary stimulus already in the pipeline.
July 10 brought two particularly damaging pieces of news. In Asia, Singapore reported that preliminary second-quarter gross domestic product plummeted at a 10.1% seasonally adjusted annual rate, which left GDP declining at 0.8% year-over-year. This marked the second consecutive quarter of contraction and put Singapore into recession, by the standard definition of the term (see BW Online, 7/11/01, "Is Singapore in Recession?"). Not only did this bring the ongoing plight of the tech sector into sharp focus but with Japan stumbling into its own recession, the entire region appears to be weakening to a degree not seen since the 1997 crisis.
In addition, recent developments in Latin America are providing flashbacks to 1998, when the Russian debt-Long Term Capital Management crisis sent shock waves throughout emerging markets across the globe. Specifically, default concerns in Argentina have been brought to the forefront with the July 10 Treasury auction. The peso's overnight interest rate ballooned to 28%, vs. 15% on July 6, which blew out the peso-U.S. dollar interest rate spread to a staggering 2,100 basis points.
As if the recent weakness in these two regions weren't enough, the European Central Bank (ECB) is doing its best to kick out the last remaining leg supporting global growth. Its recent decision not to lower rates raises the risk that the central bank's focus on backward-looking inflation data will leave it responding "too little, too late" to the global contagion.
Not surprisingly, this fragility in the global environment has been clearly evident in two areas -- the weakness in commodity prices and the strength of the dollar. The Journal of Commerce commodity price index is nearing its late-1998 lows, and has fallen 7% alone since mid-May, while the broad trade-weighted dollar index hit a 16-year high last week.
FED TO THE RESCUE?
As for the outlook, one of the Federal Reserve's stated concerns is slowing growth abroad. Given the recent deterioration and dim prospects going forward, as well as the lack of help the Fed will likely get from either the ECB or the Bank of Japan, Greenspan & Co. may have little choice but to again assume the role of "global central bank" -- just as it did back in 1998.
As such, the Fed's job may be far from done, especially given the expectations now priced in to Fed funds futures (a vehicle financial pros use to bet on the future direction of interest rates). Greenspan's upcoming congressional testimony on July 18 should provide key insight into just how concerned he is with the global environment.
And the markets? Tuesday's sell-off in the stock market was a clear indication that the weak global environment remains a present danger to corporate profits, as well as to any recovery in manufacturing. The drop in global demand, related weakness in commodity prices, and strength in the dollar all bode poorly for U.S. output and pricing power. Moreover, ongoing profit weakness raises the risk of more pain on the employment front.
The one beneficiary of the turmoil: U.S. Treasuries, which could be strengthened by flight-to-quality buying from nervous investors -- and expectations for more easing by the Fed.
MacDonald is a senior economist for Standard & Poor's Global Markets