The housing slowdown will remain a key point of discussion at the March Forum because of its strong influence on other areas of the economy. Scott Simon pointed out in December that the housing downturn will likely decrease U.S. economic growth by at least one percentage point over the next three to four quarters, and will be a primary factor that prompts the Federal Reserve to begin cutting interest rates in 2007.
Before the Fed changes its stance, however, it will need to shed lingering concerns over inflation. John Brynjolfsson argues that inflation is a lagging indicator of economic growth and that inflation pressures will recede as the U.S. economy muddles through a soft landing. At the March Forum, participants will parse recent trends in inflation and comments from the Fed to help clarify the expected timing of a shift in the Fed’s inflation view.
The U.S. inflation debate will also address the ongoing disconnect between the Fed’s stated intentions for interest rates and the rate assumptions priced into financial markets. Paul McCulley notes that while the Fed has been coy about letting go of its inflation concern, financial markets have been brash about pricing in Fed easing. Eventually, he says, the standoff will end, but regardless of whether the Fed or the markets give way first, the ultimate result will be lower rates.
Global Liquidity and Risk Premiums
Another prime issue for PIMCO investment professionals will be global liquidity and the pressure it is exerting on global risk premiums. Recent research from PIMCO will lay the groundwork for discussion about sources and sustainability of the flood of liquidity and the pressure exerting on risk premiums in financial markets.
Ramin Toloui recently determined that the flood of petrodollars amid high oil prices is compounding the already large global investment impact of China and other economies that run current account surpluses. Those reserves, in turn, are compounding the impact of significant investment capital stemming from record corporate profits, hedge funds and private equity investment.
The vast amount of global liquidity has supported heavy demand for investments, which has caused explosive growth in such products as credit derivatives, as Mark Kiesel pointed out in December. But the liquidity has also crowded many established market sectors to the point where investors are not being properly compensated for taking on risk. Bill Gross said in December that by some measures, the compression of risk premiums in asset markets is reaching a natural limit, and that markets won’t likely be able to continue producing “cream out of skim milk.”
The Global Agenda
At the March Forum, participants will also focus on how the global economy is faring in the face of the U.S. economic slowdown. At PIMCO’s December Forum, Scott Mather noted that global growth, particularly in Europe, has been surprisingly resilient amid slower U.S. growth. That resilience will keep the European Central Bank’s sights set on euro zone economic data, especially as fiscal reforms and wage negotiations push through and potentially boost inflation. In March, Forum participants will discuss any early signs of how inflation trends are progressing in the euro zone. The impact of a strong U.K. housing on Bank of England policy also remains a key discussion topic. Forum Participants will discuss whether the U.K. housing is nearing the late stages of its cycle, as Emanuele Ravano has suggested.
Meanwhile, other regions are also finding that the moderating U.S. economy is not yet sending shockwaves beyond the U.S. border. For example, Ed Devlin notes that even as Canada faces risks from slowing U.S. growth, the robust Canadian housing market, sturdy employment, steady business investment and the potential for higher government spending are offering a potential offset.
The ongoing strength in emerging markets will also be a key focus at the March Forum. Emerging markets performed strongly in 2006 amid continued structural improvements that are transforming the asset class. As with all investments, risks in emerging markets cannot be ignored, yet Curtis Mewbourne suggests that the asset class is likely to remain favourable in 2007, due to improving fundamentals and an increasing decoupling between the economies of emerging markets and industrialized nations.