| The global economic
headwinds are getting stronger and the latest
damage from Hurricane Katrina may have exacerbated
near-term worries. Indeed, numbers to be announced
in the coming month are likely to suffer –
this is already beginning to reflect in the
latest initial jobless claims as well as consumer
sentiment readings. Nonetheless, there was
considerable momentum behind the US economy
before the hurricane, and we have seen an
impressive v-shaped rebound in equity markets
shortly afterwards on the back of reconstruction
expectations. That said, we continue to see
three main risks ahead that have yet to be
fully priced in by the markets. There remains
little room for complacency.
First, high oil prices. By causing significant
damage to oil production and refinery facilities
in the Gulf of Mexico, Hurricane Katrina
helped push oil prices briefly above USD
70pb. The International Energy Agency’s
prompt response in releasing oil reserves,
together with OPEC’s decision to temporarily
remove production quotas, helped stabilise
the situation for now. However, these short-term
relief measures in turn created new concerns
– with global oil inventory now depleted,
and little spare oil production capacity
left amongst OPEC countries, the world economy
will be in a much weaker position to weather
the stronger seasonal demand for fuel in
Q4, not to mention another supply shock.
We expect WTI prices to stay high at an
average of USD 70pb for the rest of Q4,
and to remain at a far-from-benign average
of USD 60bp in 2006.
Second, the continued rise in interest
rates. With the Fed downplaying the impact
of Katrina on the US economy and sticking
to their “measured” tightening
bias after their Sept 20 meeting, chances
are that we will continued to see Fed tightening
going well into Q1 2006 as long as pipeline
inflationary pressures (stemming from high
oil prices and wage increases) remain evident.
Moreover, this trend is spreading to Asia,
whereby more and more central banks in the
region are now committing themselves to
continue to drain liquidity out of the financial
markets.
Third, the high level of global risk appetite
that is bound to wane eventually. This is
especially true for some Asian economies
that are increasingly reliant on portfolio
inflows to keep their stock markets and
currencies buoyant. Such a divergence between
market sentiment and economic fundamentals,
in our view, is unsustainable over the longer
run, and the fear is that once the lagging
impact of high oil prices and interest rates
finally filters through to the real economy
and risk appetite turns, we could see significant
asset price corrections.
All in all, one has to balance the prevailing
optimism and value offered with the three
underlying risks mentioned.
|
Bulls and Bears 
