Global Markets Weekly – 2^nd April 2007

Key Macro economic developments

• Significant data releases were fairly thin on the ground last week, but the February New Home Sales figures from the United States nevertheless provided the markets with plenty of food for thought. In the event, a further modest drop in sales was recorded during the month which, following on from the very sharp reduction seen in January, only served to highlight that the housing market downturn in the US is still some way from bottoming-out. Indeed, the supply of new homes now available for sale - expressed as a multiple of the current month’s level of demand - is at the highest level observed since 1991.
• This particular ratio now stands at a level of around eight times current month’s sales, whereas a more ‘normal’ figure is seen to be around six times, suggesting that house-building activity will remain depressed until the inventory of unsold properties reduces. The leading survey of house-builder sentiment in the US showed some signs of stabilisation towards the end of the year, but has since begun to weaken again, and the recent problems within sub-prime mortgage lending may also hit confidence over the coming months.
• However, this ‘direct’ impact of the housing market downturn – a reduced level of construction activity – has long been factored into the market’s thinking and should not, therefore, unduly influence sentiment towards the US economy. The bigger question is whether this overhang of new homes for sale will lead to price declines across the broader housing market, resulting in negative wealth effects, higher levels of default and downward pressure upon consumer spending. What does this latest retreat in new home sales tell us about these risks?
• The messages here are in truth rather mixed. Given that the new home sales statistics are based more on reservations than completed transactions, they do give an early indication of shifts in housing market activity. In some respects they may be seen as a ‘lead indicator’ of the existing home sales figures, in which a sale registered in February could have been agreed back in December. With this in mind, the bounce in existing home sales reported for February could just reflect an earlier pick-up in agreed sales, and could well prove fleeting.
• But the differing set of incentives facing home-builders and households during the sales process also needs to be considered. Whereas balance sheet constraints and the desire to reduce inventories may turn house-builders into almost forced sellers, with prices falling as a result, private home sellers may face no such pressures. The major risk facing households here is the threat of redundancy. The ongoing strength of the US labour market, and the healthy pace of wage growth, are key reason why we believe that the steady correction in the US housing market will not turn into a more worrying downturn. This makes the labour market figures of the coming months – starting with this Friday’s employment report for March – all the more important, and any sign of weakness here will only intensify the debate around the US housing market and the implications for overall growth.

Key global market developments

• While the news-flow from the US economy has disappointed over the past couple of months, the opposite has tended to be the case for the Euro-zone, with last week’s better news on the March IFO survey fitting the general pattern of stronger than expected data. But despite these diverging trends, the euro-dollar exchange has so far failed to break-out of its established trading ranges, and with some rebound likely in the US data releases expected during the second quarter, we look for the dollar post a modest recovery over the coming months. We believe that the gap that has developed in sentiment towards the US and Euro-zone economies, and the respective paths of interest rate expectations, now appears stretched and the dollar should soon benefit as this begins to close.

Indices, Interest rates and Inflation

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