On the Money: Storm clouds gather as punters pick US double dip recession

By Michael Coote

Friday 9th August 2002

Attention has been focused on the continued bear market in US shares as a possible cause for double dip recession stateside.

But it may be the US bond markets that most alarmingly signal problems ahead. Bonds are soaring on flight-to-safety money inflow as weak American statistics for July set off alarm bells over whether economic woes indicate a "jobless recovery" of the sort that helped destroy the presidency of George Bush snr in 1990-91 or, even worse, a return to recession amid fears of deflation.

George Bush jnr must be worried about facing the same fate as his father while he contemplates another military plunge into Iraq to complete Bush snr's unfinished business.

Americans care more about their domestic economy than foreign affairs, as Bush snr learned to his cost.

As with Bush jnr, war made the elder president temporarily popular but that did not save him when he sought a second term against Bill Clinton, who ran a campaign on "It's the economy, stupid."

Given his close and disputed win over Al Gore, Bush jnr must be inching ever nearer to becoming a one-term president.

Bonds have been boosted by a slew of poor economic figures, according to CNN Money's markets/bondcenter website.

The two-year bond has startled the most, dropping under a 2% yield for the first time in history.

The low yield signals that the markets agree with investment banker Goldman Sachs, which advised clients last week that the US Federal Reserve would have to cut its federal funds overnight lending rate from 40-year lows of 1.75% to 1% by year end if it was to stave off double dip recession.

The Fed cut the fed funds rate 11 times in 2001, yet failed to rescue the US economy.

News has emerged that Fed researchers are studying Japan to see what to do about a low growth and low inflation environment which, given Japan's dozen years floundering in deflationary, multi-recession doldrums despite official interest rates near zero, should bring no comfort to anyone.

The researchers concluded a sustained low interest rate climate was justified.

The big picture view might suggest monetarism is in serious trouble if its conventional interest rate responses to economic slowdown are doing no good.

A statistic that scared investors most was the July reading for the manufacturers' ISM/NAPM index, a measure of US manufacturer purchasing intentions, which fell by 5.7 points in conjunction with a 0.6% drop in the average American working week and a 1% decline in manufacturing hours.

CNN quoted Ifty Islam, head of fixed interest strategy for Deutsche Bank Securities, as saying: "These figures were horrific. The drop in hours was a shocker and might force the Street to revise down its expectations for third-quarter growth."

CNN also quoted Goldman Sachs economist Jan Hatzius as saying that the fall in the ISM/NAPM index was "shockingly weak." Mr Hatzius pointed out that the index had dropped more than five points in just 13 months since 1960 and that apart from only three occasions such markdowns had occurred either during or shortly before recessions as defined by the National Bureau of Economic Research.

The usual response to poor economic data is to buy bonds. Thus bond-watching will preoccupy markets.

Sharemarkets will be starved of investment funds while bonds are being bought, pushing equity prices lower and perhaps triggering forced sales as investors pull out of mutual funds and insurance companies dump shares to preserve capital ratios. It may be too optimistic to call the bottom of the US sharemarket just yet.

The Fed does not meet until August 13 but is expected to wait until September before cutting interest rates again.

One reason for the Fed to hang fire is that it is worried weak equities will trigger double dip recession and August is the witching month for US CEOs to sign off listed company accounts as being truthful under new post-Enron rules.

Another sharemarket rout is predicted as dodgy accounts are cleaned up and the Fed would probably want to time a rate cut to provide a psychological cushion for any panic.

If the Fed does cut rates, which would be tantamount to admitting defeat, everyone can be pretty sure the global economy is on the way down again as the US falters on weak growth now picked by Goldman Sachs to be about 2% for fourth-quarter 2002 and first-quarter 2003.

For New Zealand facing lower export prices, falling export and domestic demand, and a kiwi dollar soaring against an enfeebled greenback, the storm clouds are gathering.

ON THE WEB

money.cnn.com

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