New US Fed chief takes the helm

President Bush swore in the new United States Federal Reserve chairman, Ben Bernanke on Monday. Bernanke follows in the footsteps of two stalwart chairmen, Alan Greenspan and before him, Paul Volcker.

There are a lot of comments circulating from the myriad of experts about how Bernanke will fare in his new post, but he has an abundance of experience and in our view, is assuming a position where the obvious priority of the US Federal Reserve has to be to control inflation.

The US central bank raised interest rates by a quarter percentage point to 4.5% last week, its 14th consecutive increase since June 2004, and financial markets are betting it will increase the key overnight rate another 25 basis points to 4.75% at its next meeting at the end of March. This will be the first meeting chaired by Bernanke since he replaced Greenspan on Feb 1. Most market experts feel, and the Fed’s language in its meeting minutes and press releases indicate, that the US is nearing the end of its rate increasing cycle.

Even so, some economists remain concerned that continued increases to the core lending rates is putting a huge burden on the housing market, squeezing already over leveraged home owners. Some have gone so far as to urge the Fed to halt its tightening cycle before it does substantial damage to property prices.

However, the opposing view holds that there are a high number of home owners with fixed rate mortgages which will provide a buffer, while the number of persons with variable rate mortgages remains only a small fraction of the overall financing market.

Given that we have all known that interest rates were going to rise since 2003, we at IIL find it difficult to believe that even the most dog-ish have not locked in fixed longer term mortgages by now.

The United States:

The US unemployment rate fell to its lowest level in nearly five years last month, as US employers added a respectable 193,000 jobs to payrolls. The US Labour Department reported that the unemployment rate dipped to 4.7% in January, down from 4.9% in December and logging the lowest unemployment figure since the 4.6% figure achieved in July 2001 (just before the Sept 11 terrorist attacks). Although economists had forecast that the unemployment rate would remain unchanged from December, they also expected 250,000 new jobs to be added to keep that rate the same.

The 193,000 increase to payrolls in January was up substantially from the revised 140,000 gain in December but still well below the 250,000 gain expected indicating that less Americans are looking for work.

US paychecks increased more than expected in January as well. The US Labour Department data showed the average hourly wage rose seven cents to $16.41. The 0.4% increase was slightly more than the 0.3% gain forecast by economists.

Over the last 12 months, average US wages are up 3.3% on a seasonally adjusted basis, the biggest 12-month change in nearly three years and almost double that of inflation. In conclusion, the financial condition of US workers is improving and it seems to us that anyone who wants a job, can get a job.

It now appears the US is moving toward a new economic problem, that of a tight labour market and the inherent problems it will put on inflation, vis-a-vis upward pressure on wages and product prices. We already have upward pricing pressure from energy costs, and now with labour adding more pressure, it seems unlikely the US Fed could consider not increasing the over night interest rate in late March.

Looking ahead:

The state of the leading economies of the world remains strong and in a stage of controlled economic expansion. As we move into a more mature economic growth period, concern over inflation and accelerated growth should be paramount. There remains a lot of cash looking for investment opportunities and an abundance of savings, especially in the large oil exporting nations.

Please be reminded that the global trade imbalance does not relate only to spending, but to savings as well. Clearly, if you are making money by selling your products, but saving the money, ie taking it out of the trade equation, it becomes difficult, if not impossible to balance trade.

As for investment options, ownership investments remain the favoured choice. And stocks did very well in January, thus if you believe in the January barometer, 2006 looks to be a great year for stocks.