Weekly Economic Commentary
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On the Other HandWeekly Economic Commentary
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On Pins and Needles
The Art of Deleveraging a Government
Decoupling Continues
Thank You, Commodity Markets
Indexes at a Glance
On Pins and Needles
The initial knee-jerk reaction of global stock and currency markets to the modest uptick in the U.S. Federal Reserve (Fed) discount rate provides insights into the ongoing nervousness of the financial markets regarding withdrawal of accommodative monetary policy. Fortunately, even though the financial markets were apparently caught off-guard and didn't initially like what they heard, as the week progressed the markets gradually became comfortable with the view that the Fed decision represents more of a technical move than a material change in monetary policy. Indeed, the Fed's move essentially completes a return to early 2007 when the Fed discount window was a rarely used emergency borrowing facility for overnight credit, priced to generate a higher return than the Fed funds rate. We believe credit markets are now sufficiently healed that there is much less demand for such an emergency borrowing facility than there was in 2008-2009. In fact, the demand for emergency capital at the discount window (the discount window is an instrument of monetary policy [usually controlled by central banks] that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions) is now back to levels seen prior to the bankruptcy of Lehman Brothers, having peaked at around $110 billion in late 2008, but currently at less than $20 billion.
The Art of Deleveraging a Government
The market consternation that has led Greece (and other Euro nations) to develop into the first major credit issue of 2010 has both Euro-specific overtones as well as broader macroeconomic origins and implications. Specific to the Euro zone, the recent challenges once again raise the question whether a multinational government apparatus that combines centralized monetary policy with decentralized fiscal and tax policy is really a workable and credible model. This is especially true in a situation with a spotty history of compliance, with an average of more than 40 percent of the European Monetary Union (EMU) member nations being out of compliance1 since 2002. Nevertheless, the markets are gradually coming to the conclusion that a solution will be found to Greece's situation, which has allowed risk appetite to return to the broader markets and led to a decent week of stock market performance.
Decoupling Continues
Europe's predicament provides further evidence of the dynamics of global decoupling (the ability of an economy to grow without corresponding increases in environmental pressure). As a result of both elevated sovereign default risk and a weak outlook for the European economy, we believe the Euro will likely remain under pressure throughout 2010. That is particularly true for its exchange rate against the dollar as the financial market begins to contemplate the first hike in the Fed funds rate. As recently as early December 2009, the Euro was above $1.50 (for the first time since August 2008), but its momentum has dramatically reversed with the Euro falling by about 10 percent. The International Monetary Fund (IMF) projection of just 1 percent real Gross Domestic Product (GDP) growth in Europe for 2010 reflects a weak economic expansion that, if accurate, will manage to be only one-fourth the pace of projected global GDP growth.
Thank You, Commodity Markets
Australia, and especially Western Australia, has been the recipient of a significant improvement in sentiment in 2009 and into 2010 as a rebound in commodity prices and China's continuing strong growth have provided economic and job growth momentum. But the wealth effect and strong employment growth in the commodities and shipping business have also led to a continued increase in housing prices in Perth, despite the Australia government raising interest rates (albeit with a recent pause) to ease inflationary and asset reflationary pressures. The Australia economy does remain somewhat vulnerable to China tapping on its stimulus and credit formation brakes, but a strong banking system and consumer spending have kept Australia out of recession throughout the entire global credit crisis.
That is not true of one of the BRIC (Brazil, Russia, India and China) nations that is also a commodity-driven economy; that being Russia. After a poor 2009 in which the Russian economy contracted by nearly 9 percent, the rebound in oil prices suggests a much better year ahead for Russia in 2010. Much like the Euro zone, the Russian government incurred large budget deficits, but if oil prices stay elevated, Russia likely has the means to pay for it by virtue of being a major oil exporter.
Indexes at a Glance
Information provided by Principal Global Investors.
| Indicator | Close
as of 2/19/10 |
Weekly Change |
YTD Change |
Weekly % Change |
YTD % Change |
| Dow Jones Industrial Average | 10,402.35 | 303.21 | -25.70 | 3.0% | -0.2% |
| NASDAQ | 2,243.87 | 60.34 | -25.28 | 2.8% | -1.1% |
| S&P MidCap 400 | 740.16 | 24.20 | 13.49 | 3.4% | 1.9% |
| S&P 500 | 1,109.17 | 33.66 | -5.93 | 3.1% | -0.5% |
| S&P SmallCap 600 | 335.57 | 11.52 | 2.94 | 3.6% | 0.9% |
| MSCI EAFE (Intl.) | 1,490.05 | 24.31 | -90.72 | 1.7% | -5.7% |
Performance of indexes reflects the unmanaged result for the market segment the selected index represents. The index is not available for direct investment.
1 The Maastricht Treaty in 1992 specified that each EMU nation is subject to limits on total public debt (60 percent of GDP) and annual budget deficits of no more than 3 percent of GDP.
The commentary represents the opinions of Principal Global Investors and may not come to pass.
The S&P 500 is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market.
The S&P MidCap 400 Index includes approximately 10% of the capitalization of U.S. equity securities.
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