Commentary Keith Wade, Group Chief Economist and Strategist, and his colleagues within the Schroders’ economics team.

Date: 31 Oct 2009


Key points this month are:

Global: The dollar, re-balancing and the world economy

• The US dollar has closely tracked swings in risk appetite with the rate against the euro moving in lock step with the S&P 500 over the past two years. Amongst the major currencies, strength and weakness is closely related to the severity of the credit crisis in each economy, with sterling being one of the worst hit.

• Meanwhile, there has been little official comment from the US on the latest fall in the dollar. An implicit acknowledgement no doubt that a more competitive currency is needed to narrow the trade deficit and rebalance the economy. This is certainly true, however, the bulk of the deficit is with countries whose currencies have not moved significantly, many of which can be found in the emerging markets.

• This is one reason to expect an appreciation of the emerging currencies, however, with many tied to the dollar such a move is a political decision and hence will be gradual. Consequently, the burden of adjustment will continue to fall on the majors, particularly the euro and yen – both of which are already expensive.

Focus – Inventory cycles 101

• De-stocking by firms in response to large falls in demand creates a drag on GDP. However, as demand begins to recover, firms replenish depleted inventories, with the additional output resulting in a temporary bounce in GDP.

• While the theory provides a neat story, our empirical analysis finds that Eurozone economies tend to see a less noticeable boost from inventory cycles, which is spread thinly over several quarters. Non-Eurozone (G7) economies tend to follow prevailing wisdom, receiving a pronounced bounce in the first two quarters, with the effects fading thereafter.

• Our assessment suggests greater upside risk to our US, and to a lesser extent, UK growth forecasts. However, the results also support our view that a “W” shape recovery profile is likely. In terms of strategy, commodity prices are likely to be well supported ahead of the re-stocking phase of the cycle. The consumer discretionary sector is likely to underperform until unemployment begins to fall, which is unlikely until re-stocking is well under way.

• Finally, corporate earnings should continue to improve during the current de-stocking phase, but then disappoint once we enter the final stage of the cycle.

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