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US economy to underpin commodities
Garth Theunissen
Posted: Fri, 11 May 2007

[miningmx.com] -- COMMODITY exporting countries such as South Africa could benefit from the current economic slowdown in the United States, said a leading economist.

First National Bank chief economist, Cees Bruggemans, said a weaker US economy could prompt the US Federal Reserve to cut interest rates, thereby stoking demand in the world's biggest economy and narrowing the spread between US and global interest rates.

That would keep the flood of yield-seeking liquidity pouring into emerging market equities while an interest rate-led revival of US consumerism would keep China's export juggernaut hungry for commodities.

Said Bruggemans: "The world - and South Africa - isn't served well by a recessionary US. But the best of both worlds is for the US to struggle a little, favouring lower interest rates as a catch-all solution to all its shortcomings, along with a gradually weakening dollar. Just like a little inflation, that can grease the global wheels wonderfully - at least for some time.

"If simultaneously the rest of the world were to continue showing independence in its economic affairs - making enough spending steam in such diverse locations as China, India, Europe, Opec, Latin America and even Japan - the world would be able to keep on steaming. It's a world view that smiles on commodities but also on emerging markets requiring access to global liquidity."

However, keen readers of the financial press may have noticed that this tidy little arrangement doesn't quite fit with some of the more recent facts, the most obvious being a warning from Fed chairman, Ben Bernanke, that continued rising inflation in the US might actually necessitate a rate hike.

The US headline inflation rate rose to 2.8% in March 2007, while core inflation for the same month was 2.5% - a touch higher than the Fed's comfort level of around 2%.

However, Bernanke's comments must be seen in the light of a US Commerce Department report that showed the US economy grew by a mere 1.3% annualised pace in the first quarter of the year, compared with 2.5% in the fourth quarter - far slower than many imagined.

Moreover, that prompted no less than three investment houses - Goldman Sachs, Merrill Lynch and UBS - to say publicly that Bernanke was "wrong" to argue that persistent inflationary pressures may necessitate a rate hike.

In fact, the three brokerage firms have forecast that the Fed would cut its target rate from 5.25% to as low as 4% by year-end 2007.

Jan Hatzius, chief economist at Goldman Sachs, recently told Bloomberg News that the Fed would cut rates three times this year, to 4.5% from the current 5.25%.

On the South African front, Brait economist Colen Garrow said the Fed was likely to trim rates, despite the mild up-tick in US inflation.

Said Garrow: "If inflationary pressures were solely demand driven, a case could be made to hike rates. However, prices are being fuelled by more expensive energy costs. And if problems in the sub-prime housing market are any indication, chances are better than even that the next movement by the Fed could be to take rates lower."

Of course, it must be pointed out that the US economy is hardly in dire straits just yet. According to the US Labour Department, the US economy added 180,000 jobs in March, almost 30% more than expected.

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Bruggemans said that the US economy, which averaged around 2% growth last year, is still underperforming. "The US's potential growth rate is 3%, so there's still plenty of room for growth at current levels."

Nevertheless, a mild underperformance by the US economy is good news for the global economy, as it's likely to result in the Fed keeping US interest rates low. "Market expectations of slower growth and weaker interest rates are the ideal combination for the rest of the world," said Bruggemans. "Equity markets don't like slower growth but they do like lower interest rates."

What's more, Bruggemans said he could not see a dire end to the US growth cycle. "Overall, the picture is still benign. US growth should remain strong enough to sustain the global economy but weak enough to sustain financial markets, through lower interest rates. And, by extension, that should be good news for commodities in general."