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Market Review: Our Current Account Woes

In this month's commentary Tyndall Investment Management managing director Anthony Quirk comments on New Zealand’s dreadful current account deficit and trade imbalances around the globe.

Wednesday, October 4th 2006, 3:44PM

by Anthony Quirk

This market summary is provided by Tyndall Investment Management. To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Review here

New Zealand’s dreadful current account deficit for the June quarter of 9.6% of GDP (rightly) generated headlines when it was released in September and reinforced the issue of trade imbalances around the globe.

The US currently has a significant trade deficit but has traditionally received positive interest income. However, the US is now paying out more to foreign lenders than it is receiving for the first time in at least 90 years. It currently owes US$2.5 billion, a small amount in the context of the huge US economy but a trend that could quickly accelerate to New Zealand-type proportions if the US continues to rack up large trade deficits. This comes at a time when a weaker US dollar is actually helping their trade position, but clearly not enough!

Of course one country’s deficit is another country’s surplus and part of the western world’s deficit issue is oil related with the oil producing nations well in surplus. Even Russia has a 12% trade surplus currently. But this is not the full story with oil importers such as China and Japan still enjoying trade surpluses. These surpluses have to find a home and are partly being re-invested into increasing productive capacity, although in the case of China one could argue that over-investment may be going on there at present. This is a key reason why the Chinese Government is trying to slow its economy.

The surpluses are also going into investments around the globe and this is one of the factors behind global bonds doing so well recently (as well as the Kiwi dollar) as investors seek high yielding but safe investment areas. Thus we could continue to see a situation where western countries such as the US and New Zealand receive investor inflows from Asian countries which are generating surpluses. However, a deficit of New Zealand-like proportions cannot continue indefinitely.

Here are three possible scenarios that could resolve our current account woes.

Global Growth Slowdown Unfolding

A key reason that global bonds have performed strongly in September is the reality that the global economy is slowing down from historically high levels. Many indicators are pointing to this slowdown, including the OECD leading indicator which is significantly lower from levels earlier this year. This reflects downturns in the US, Europe and Asia. For example, in Germany growth expectations are lower as that country looks to increase its Value Added Tax by three percentage points to 19%. The attempted managed slowdown in China is underway with leading indicators in other Asian countries such as South Korea and Taiwan also reducing.

Investor perception of an imminent global economic slowdown provoked a savage adjustment in some commodity prices. The Commodity Research Bureau (CRB) index had its biggest drop since the 1974 recession! The oil price decline through the month was part of this, with crude oil prices 20% off their peak. Oil price hikes earlier in the year have been a tax on consumers and now a price fall might be a catalyst for a lower inflationary/higher growth scenario. Consumer and business sentiment indexes already seem to be reflecting a slight improvement from lower petrol pump prices.

Company responses will be interesting to note with some having experienced margin squeezes with oil price rises. The temptation must be, if market forces allow it, for these same companies to try to hold on to margins in the face of commodity price falls. Air New Zealand appears to be one obvious local example of this. It has been struggling to catch up with previous rises in its input costs and will now probably try to take its time in passing on the benefits of lower oil prices to its customers.

The silver lining to this is that global inflation pressures have eased. US inflation has probably peaked and is falling through Europe with the most recent monthly CPI readings all negative in Germany, Spain and Belgium. This is also being reflected in New Zealand. The latest National Bank Business Survey shows declining petrol pump prices have had an immediate effect on inflationary expectations and pricing intentions. The latter is now at a six month low – the sort of thing the RBNZ loves to see!

So Central Banks, particularly in the US, can now contemplate easing rates in 2007. In terms of the timing of this it seems that the Federal Reserve in the US is now more likely to cut rates earlier than the RBNZ. We would not have predicted this 6 months ago and is a key factor behind the recent resurgence in the kiwi dollar.

While it is decelerating the global growth outlook is still good with a soft landing still the most likely scenario. A moderate growth and inflation scenario is potentially the best of both worlds and bullish for both bonds and equities. Previously I thought it would be difficult for bond yields to go materially lower and help drive up equity valuations. However, lowering bond yields through September have helped sharemaket valuations. So while there are still many potential risks globally, the overall outlook is reasonably positive, although investment returns are very unlikely to match the levels of the past three years.

To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Review here

Anthony Quirk is the managing director of Tyndall Investment Management New Zealand Limited (Tyndall).

Anthony Quirk is the managing director of Guardian Trust Funds Management.

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