IT COULD scarcely be more ironic that this week’s annual meetings of the International Monetary Fund and the World Bank will take place in Singapore, rather than their usual home in Washington.
As finance ministers and central bank chiefs from across the globe touch down in the Asian city-state this week, they will be acutely aware that the greatest concern they face lies on the far side of the world, with the US economy.
America’s uncertain prospects inevitably will be a dominant theme of this week’s Singapore gathering. As was discussed here last month, the United States is now in an unenviable predicament, gripped by conflicting pressures from rapidly weakening growth alongside elevated and accelerating inflation.
The dilemma that this nasty brew has inflicted on the US Federal Reserve is intense. To tighten the interest-rate ratchet to quell what are really quite fierce inflationary pressures would risk tipping America into a nasty downturn. Failing to do so could permit inflation to become re-embedded in the US economy.
This column argued last month that, although a US slowdown ultimately ought to cap inflation, Ben Bernanke, the Fed’s Chairman, nonetheless should make absolutely certain that price pressures were tamed by pushing through a further, unpopular rise in interest rates. It seemed then, as it still does, that the potential cost of allowing inflation to tighten its grip was too high for the Fed to afford.
Well, we now know that the Fed opted instead to call a halt to its campaign of rate rises after the previous 17 straight increases. Inflation remains a real threat, as emphasised last week by official figures showing that US unit labour costs shot up in the second quarter at their fastest annual pace for six years.
Yet the reality is that, with fears over the US housing market intensifying daily and other indicators of future economic activity cooling markedly, the moment for further Fed action may now have passed.
Whatever Mr Bernanke ought to have done, the chances are that US interest rates have peaked. The Fed chief has put his — and everyone else’s — money on sustaining growth, and rolled the dice. The question on everyone’s lips in Singapore will be whether this high-stakes wager will pay off. Just how sharp will the coming US downturn be? The apparent severity of the present, continuing correction in America’s once-booming housing market is fostering the belief that it could be quite brutal. On Wall Street, the “R” word — recession — is whispered in increasingly anxious tones. At the least, the growing nervousness over the US outlook seems destined to make for a turbulent autumn in financial markets.
It is certainly true that the slowdown in the housing market has been pronounced. From peaks above 15 per cent in the autumn of last year, house price inflation on existing homes has collapsed to near-zero. A similarly drastic trend can be seen in prices for new-build properties. In the second quarter, the average US house price rose by only 1.2 per cent, the weakest gain since 1999, and analysts believe that prices may soon succumb to year-on-year falls.
It is true, too, that the boom in the American housing market has been a key driving force in maintaining the recent strength of US economic expansion. Surging house prices allowed homeowners to cash in on the resulting rapid increases in their wealth, borrowing against soaring property values to finance consumer spending.
Inevitably, then, stagnant or falling prices can only have big repercussions as homeowners become far more reluctant to borrow against their properties and try to bolster savings. The effects will, unavoidably, be magnified by the impact on household confidence.
Still, some perspective is called for over the scale of the likely consequences.
First, as Steven Wieting, of Citigroup notes, it is worth remembering that the US housing slowdown is not really a new development. Sales of homes have been falling for well over a year, while investment in residential building has dropped for three quarters in a row, and the peak in US house price inflation was roughly a year ago. Throughout these trends, the American economy has proved resilient. This offers some reassurance.
Secondly, Mr Wieting also highlights the reality that probably only a small part of the money borrowed by Americans against their homes has actually been spent — mirroring the pattern seen in British “mortgage equity withdrawal” (MEW), according to the Bank of England.
Indeed, Citigroup calculates that US real consumer spending would have risen by a scorching 11 per cent over the past year if all of the funds extracted through US MEW had been spent — rather than the more modest actual figure of 3 per cent.
Finally, there are also question marks over the additional fear that many American borrowers will be hit hard by sharp rises in their interest payments when fixed-rate deals put in place in 2003 run out. Citigroup estimates that only 5 per cent of US mortgages taken out at the trough in US interest rates in 2003 should be affected: a relatively small cadre of homeowners.
So while there is no question that the US housing market downturn is severe, and will have serious economic consequences, it ought not to prove quite the cataclysm that the most pessimistic doom-mongers suggest.
My own bet is that the American economy will safely escape recession, even though the blight of persistent inflation will limit the Fed’s scope to make early interest rate cuts to underpin activity. One important supporting factor will be that weakening US prospects, and the likelihood of eventual cuts in rates, should push the dollar still lower, boosting American export trade. Another will be the relatively robust health of the US corporate sector, which has reaped the benefits of a protracted profits boom.
Until the trends become clearer, though, none of this is likely to spare policymakers an edgy few days in Singapore — nor markets and the rest of us an anxious autumn ahead.
