MSE | Wednesday, 26 September 2007

Outrageous predictions?

World Markets and Fund report weekly round up to 25th September 2007

One of the predictions in my January 2007’s article entitled ‘Outrageous predictions for 2007’ was for a US recession at year’s end. At the time, this probably seemed ludicrous to many following the fantastic growth enjoyed in 2006 however, in the article I detailed how 2006 had seen one of the sharpest decelerations in US housing price history and I suggested this was set to continue throughout 2007, as higher interest rates finally caught up with consumers.
Another prediction in the same article was for the US Federal Reserve to cut interest rates to 4% by the end of 2007. In January, US interest rates were at 5.25% and although some movement was anticipated slashing rates to this level at that time was seen as very unlikely. This prediction was made based on a slowing US economy and was calculated to be the likely response of a US Federal Reserve overseeing an economy slipping closer and closer to recession.
Last week the US Federal Reserve cut their interest rates from 5.25% to 4.75%, a decisive cut of 50 basis points rather than the smaller and more widely expected 25 basis points. This was done for a number of reasons. First of all, it was done in order to help stabilise the current volatile financial markets by sending out a clear message from the Fed that they will intervene when necessary. Secondly, it makes borrowing cheaper which it is hoped will encourage the American consumer to spend more thereby stimulating growth. Finally, rates were cut to offer some help to those currently in trouble with their mortgage payments in an attempt to avoid another estimated 500,000 US home loan foreclosures in the coming year.
Last week, the highly respected former Federal Reserve Chairman, Alan Greenspan said that earlier in the year he thought that there was about a one-third probability that the US could slip into recession this year and although he now feels this has come up somewhat, at this stage he feels it is still less than a 50% chance. In January, the prospect of the American economy entering a recession by the end of the year seemed farfetched. Hopefully, last weeks actions by the US Federal Reserve will prove to be a turning point but the prospect of an American recession has not disappeared and certainly doesn’t seem as outrageous as it did almost nine months ago.
The leading stock market indexes certainly reacted positively to the cut in US interest rates with most showing good, positive gains. In Germany carmakers were among the biggest risers on Friday, lifted by brokerage Goldman Sachs upgrading its opinion of shares in the sector. Shares in BMW ended up 3.4%, while those of Daimler added 1.8%, and Volkswagen advanced 1%. Tyre-maker Continental was also lifted, up 5%. But German banks were badly hit at the beginning of this week as investors continue to worry about their exposure to the US Sub-prime crisis with Deutsche Bank shares falling 2% on Monday on reports that the credit crunch may cost it 1.7 billion euros.