The world speculated all year about who would succeed Alan Greenspan as the new Chairman of the Federal Reserve at the end of January, following his 18-year tenure. Speculators had narrowed the field of candidates down to 6 and then to 4. The favorite was Bernard Bernanke (Chairman of the Council of Economic Advisors), followed closely by Glenn Hubbard (Dean of Columbia Business School) and Martin Feldstein (an economist at Harvard University). Donald Kohn (Secretary of the Federal Reserve’s Open Market Committee since 1987) was seen as the “dark horse”. The two outside candidates were Roger Ferguson, current Fed Vice Chairman and John Taylor, an academic economist from Stanford University.
Bernard Bernanke’s key strength is that he is an “outspoken advocate of inflation targeting”, however, his “limited non academic experience” is a potential negative. Glenn Hubbard is viewed as being a strong supporter of tax cuts, while Martin Feldstein has been a “key architect of Mr Bush’s plan for social security reform” and was chief economic advisor in the Reagan administration. Donald Kohn, in his role as Secretary of the Federal Reserve’s Open Market Committee since 1987 has had “a ringside seat watching Mr Greenspan run the Fed” and was possibly “best placed to preserve his [Alan Greenspan’s] legacy”.
The speculators had it correct. Months of speculation were ended on 24th October when George Bush announced that Bernard Bernanke would replace Alan Greenspan to become the 14th Chairman of the Federal Reserve in January next year. Wall Street reacted favorably to the news. Not everyone was pleased by the announcement, though, as concerns were expressed about Benanke’s “little experience outside the economic realm”.
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| Source: BBC.COM | |
Responding to the news of his appointment, Mr Bernanke said, “my first priority will be to maintain continuity with the policy and policy strategies under the Greenspan era”. However, there are some who wonder how he aims to achieve this in view of the fact that Alan Greenspan is famous for his view that Central Banks should keep the markets guessing on “how tough they would be on inflation”, whereas Mr Bernanke is known to be a firm promoter of inflation targeting. Inflation targeting is used by the Bank of England and the European Central Bank, where the “central banks set a target for inflation and stick to it”. A remark that he made in an address to the National Economists Club on 21st November 2002, which he has tried to imply was made tongue in cheek, has come tack to haunt him. He said, “like gold, U.S. dollars have value only to the extent that they are strictly in limited supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” How will he deal with this issue, we wonder?
While Mr Ben Bernanke has much to celebrate, there will be little time do so once he takes up office next year. He will need to be focused on dealing with pressing issues such as the balancing act of raising interest rates in the face of the recent tropical storms, the potential impact of consistently high oil prices on inflation, the growing trade deficit, the housing price “bubble” and the US Dollar, to name but a few. This will clearly not be an easy task, especially with the whole world watching and waiting to see how he plans to address these issues.
| UNITED STATES OF AMERICA |
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Following 12 consecutive increases, interest rates reached their highest level since the spring of 2001. In a unanimous decision, rates were increased by another 0.25% to 4%, when the Federal Reserve met on 1 November. The statement released after the meeting by the Federal Reserve indicated that, although the “cumulative rise in energy and other costs have the potential to add to inflation pressures, core inflation has been relatively low in recent months and longer-term inflation expectations remain controlled”.
Because the Federal Reserve have indicated that they will continue to increase rates at a “measured pace”, the market is expecting at least another two 0.25% increases – one at each of their meetings scheduled for the 13th December and the 31st January (Greenspan’s last meeting).
There is much debate about what Benanke will do.
Will he continue where Greenspan left off, or will the Fed raise rates by 0.50% in December to avoid raising rates in January, making a clear distinction between the Greenspan “era” and the new Benanke “era”? Some believe that consumer spending patterns will be one of the key factors that Benanke will need to keep a close eye on.
Amidst fears that the recent hurricanes would impact severely on economic growth, the latest figures released have confirmed that 3rd quarter GDP growth came in above forecast expectations (of 3.6%) at 3.80%. This is better than 2nd quarter GDP, which was 3.3%. This number provides support for the view that the Federal Reserve is likely to continue raising interest rates for the time being.
According to statistics recent hurricanes (Katrina and Rita, but excluding Wilma, the most recent hurricane) trimmed some 502 000 jobs in the United States in September and October. However, the Labor Department has confirmed that the “number of hurricane related claims have been leveling out after the initial rush in mid September following the hurricanes.” In October the unemployment rate declined to 5%, with 56 000 new jobs being created. Household debt levels relative to disposable income increased to 124% in the 2nd quarter, increasing from 117% a year ago.
| EUROPE |
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Interest rates remained at 2% for the quarter under review, having stayed at these levels since June 2003. Inflation is currently 0.50% above the target of 2%, largely due to the consistently high oil price. The European Central Bank has received calls for both interest rate cuts and increases this year, making their decision regarding the next rate move an extremely difficult one. The region is faced with inflation above its target on the one hand, and slower growth due to higher commodity prices on the other hand. The remedy for one is to raise interest rates, while the solution for the other is to reduce rates. The ECB has alluded to possible rate increases soon. However, the Organisation for Economic Co-operation and Development (OECD) have recently warned against rate increases until the second half of next year to avoid stifling economic improvement in the region. They are of the opinion that there are currently no signs of “inflation spreading”.
Eurozone GDP growth in 2004 was 2.1%, however, forecasts for growth in 2005 have been revised down to 1.2% from 1.6% previously. Commenting at a presentation to the Danish Central Bank recently, head of the European Central Bank, Jean-Claude Trichet said “you will probably share the view that the growth performance of the Euro area cannot be deemed fully satisfactory. But it is equally true to say that the single monetary policy, geared towards price stability and the anchoring of inflation expectations, lends ongoing support to economic activity.” The Euro has weakened by more than 15% against the US Dollar this year, fuelled by disappointing economic growth in the region which has resulted in interest rates being lower than those of its main trading partners. Other factors that have impacted negatively on the currency include the German election debacle, together with a number of failed referendums (France and the Netherlands).
| UNITED KINGDOM |
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The Bank of England kept rates on hold at 4.5% during the quarter under review. The “no change” decision at the November 10th meeting was widely expected following on from data indicating that inflation had reached new highs in September. Inflation fell to 2.3% in October (from 2.5%) and is currently 0.30% above the target. Business leaders were disappointed with the news, having called for a cut in rates to provide “a much needed boost” for the manufacturing sector.
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Gordon Brown has already conceded that GDP growth will not be in line with his target of between 3% and 3.5%, as set out in the last Budget. According to the Ernst and Young Item Club, GDP growth is expected to be as low as 1.6% for 2005 and they are “cautiously predicting” GDP of 2.2% for 2006. This is sharply weaker than the 3.4% GDP growth recorded in 2004. Commenting on these figures, Professor Peter Spencer, the chief economic advisor for the Item Club was far from complimentary.
He said “the chancellor is blaming the UK economic slowdown on the recent spike in oil prices and the weakness of the European economy, but this is unrealistic. The problems were plain to see at the time of last year’s pre-Budget report in December, but instead of addressing them then, the Treasury chose to dress up the UK finances for the election.”
Business confidence has weakened and consumer spending has slowed sharply this year. The main factors contributing to this have been the softening of the housing market, combined with the high oil price and a high interest rate environment.
| JAPAN |
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Despite evidence that the economic recovery appears to be gaining momentum, deflation continues to plague the region. Interest rates have remained close to zero for four years and are likely to remain accommodative until there is evidence that deflation is well and truly out of the way. Commenting shortly after the release of the better than expected third quarter GDP figures, Bank of Japan Governor, Toshihiko Fukui said “rises in prices may not accelerate, but it’s unlikely that they will fall back into negative territory once they start rising.” Private sector demand, which has been boosted by wage growth being positive for the first time in many years and full time employment rising for the first time in almost a decade, has been one of the main drivers of the economic expansion this year. This is unusual in that Japan has always been viewed as an export driven economy. In contrast to 2004, net exports have not been the main drivers of growth this year. Increased capital spending, which is being boosted by robust corporate earnings, is also having a positive impact on the household sector, thereby improving consumption.
Junichiro Koizumi’s landslide election victory in September, which now allows him to sell state assets to reduce debt and to implement other reform policies in an attempt to extend the economic recovery, was well received by the markets. Koizumi has indicated that he intends to step down as party leader in September next year. Following his election victory, he reshuffled various senior posts within the cabinet. These moves “were closely watched for clues as to his priorities for the remainder of his term as leader, as well as pointing to his potential successor.” The Bank of Japan has estimated that this fiscal year GDP growth is likely to range between 2.2% and 2.5% and that in the 2006 fiscal year it is expected to range between 1.6% and 2.2%.
| SOUTH AFRICA |
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Will domestic interest rates remain level for longer or will they start to rise in 2006? This debate continues daily and the consensus view changes almost as often. Consumer inflation surprised the market by declining in September (to 4.7% from 4.8% in August), but this news was short lived when it was announced that September PPI (Producer Price Inflation, often an early indicator of what inflation in likely to do) increased by the largest margin in two and a half years. This fuelled concerns of an interest rate hike in December.
Adding to these fears were the Governor’s recent hawkish comments with regard to the second round inflationary effects brought about by the high oil price. However, CPIX declined to 4.4% in October, while PPI surprised the market by coming in below forecast. Encouraged by these numbers, concerns of an interest rate hike in December have been eased, with some economists predicting that the likelihood of a rate increase in the first half of next year is now remote. The current forecast by the Reserve Bank is that CPIX should peak at 5.8% during the second quarter of next year, before reducing to 5.3% in the last quarter of 2007. Factors that could impact negatively on these forecasts are the unit cost of labour, the Rand and the direction of oil prices. Despite inflation having remained within the targeted band for the last 25 months, it has risen fairly sharply from levels of 3.5% in June. The Rand ended the quarter unchanged against the US Dollar, from the closing spot price at the end of the previous quarter. The currency appreciated by 3.87% and 4.03% against the British Pound and the Euro, respectively, over the same period.
Trevor Manuel released the Medium Term Budget Policy Statement (MTBPS) on 25th October, the purpose of which is to outline the medium term expenditure structure of the government and to provide an update of the fiscal developments since the “formal” budget in February. The highlights were as follows:
- reduced fiscal debt as a result of an expected excess revenue collection of approximately R30 bn
- due to sustained investment spending, GDP growth has been revised upwards
- with immediate effect the lifting of “foreign exposure limits on unit trusts and investment managers to 25% of total retail assets from 20% and 15%, respectively.”
According to the National Treasury, this could mean an outflow by South African banks of up to R48 bn, should they take advantage of the new ruling, while unit trusts are now able to invest a further R20 bn offshore. In addition, there has been some speculation that Government is looking at relaxing exchange controls on individuals (either in total, or by increasing the current limit of R750 000 per person over the age of 18) once the amnesty process has been completed. Reports indicate that, as at 30 September 2005, some 90% of the 43 102 applications had already been processed. The Governor of the Reserve Bank has openly called for exchange controls to be lifted completely. Could this mean that taxpayers can expect good news in this regard as early as the annual budget in February?
| GENERAL – OIL AND GOLD |
The oil price declined over the period to end the quarter at $52.33 a barrel from the previous quarter close of $66.26. Despite the sporadic declines in price, supply and demand issues as well as refinery problems remain.
The gold price rose sharply, reaching 18 year highs of over $500 an ounce during the quarter under review. Gold last reached these levels in 1987 when the price touched $503.50 on the 15th December 1987. The gold price ended the quarter at $494.30 an ounce, up 14.57% from the close of $431.45 at the end of August. The rise from levels of $250 an ounce just three years ago has been significant. It is believed that global inflationary fears and “safe-haven hedge buying” are the main drivers of the price, with many investors “being uncomfortable with currency and bond markets”. Strong “physical and investment demand” from Asia has also put upward pressure on the price.
| CONCLUSION |
With this being our last report for 2005 we would like to take this opportunity to wish you and your family a peaceful and happy festive season and a prosperous new year. Please make a note that our offices will be closing at midday on Thursday, 22nd December and will reopen on Monday 2nd January 2006.
QUARTERLY QUOTE
“Life consists not in holding good cards but in playing those you hold well”
John Billings
This report is based on information sourced from various institutions, both local and international. The report reflects a variety of views and is not intended to convey investment advice. Please consult us to obtain specific advice relevant to your investment portfolio.
