Wed, Aug 20, 2003 page12

• Economists hedge bets on US

  PESSIMISM Investors appear confident but analysts are warning that high oil prices, growing unemployment and rising market interest rates are reasons to be cautious

  • AFP
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  Fear is creeping into the celebrations over an upswing in the US economy.

  Recovery signs are abundant, from surging consumer spending to rising factory output and most economists forecast a gradual economic pickup in the second half of this year and next year.

  Investors, glimpsing better times ahead, sent Wall Street's blue-chip Dow Jones industrial average up 90.76 points, or 0.97 percent, to 9,412.45 on Monday, the highest finish in more than a year.

  But in the shadows, higher oil prices, the still-large portions of industry lying idle, unemployment and rising market interest rates are leading some analysts to squeeze the champagne cork back into the bottle.

  Past experience of the shocks from the Sept. 11 attacks, a stock market slump and corporate scandals, combined with new risks, have raised questions about the longer-term durability of the recovery.

  "I don't think we are yet at the point where we can declare the economic recovery to be self-

  sustaining," said Moody's Investors Service chief US economist John Lonski.

  "It is premature to state at this time with confidence that the US economy will no longer require additional external assistance from either the Federal Reserve or from fiscal stimulus."

  Among the key risks are:

  Oil

  Economists at Morgan Stanley raised the forecast for a barrel of Brent North Sea crude oil from US$25 to US$29 at the end of this year and from an average US$24.50 to US$27 next year.

  "For the global economy, this should not be a major impediment on the recovery road. However, relatively higher oil prices are likely to limit the strength of the recovery and influence policymakers," they said in a report.

  Mortgage rates

  The housing market helped power the economy through a tough last year and this year as people took advantage of lower rates to cut their monthly payments and to finance shopping.

  But the Mortgage Bankers Association of America (MBA) on Monday cut its forecast for new mortgages this year and next, blaming a rapid rise in mortgage interest rates.

  "We have been forecasting mortgage interest rates to slowly increase, eventually drying up the refinance market, but the recent upsurge in rates has moved that event forward," said MBA chief economist Douglas Duncan.

  Corporate strength

  Investors still view corporate debt as being much more risky than benchmark government bonds, although the difference has narrowed a little.

  And Lonski noted a relatively high level of corporate credit rating downgrades by the major rating agencies.

  "By no means does corporate America possess the financial vigor that it did in 1992, never mind 1993 through 1997," Lonski said.

  "In all honesty, the biggest danger facing the US and world economy would be another jarring external shock that takes the form of nine-11 type terrorist attacks, perhaps that includes the run-up of oil to maybe US$35-US$40 per barrel," Lonski said.

  If the economic recovery was to run out of steam, the Federal Reserve would still have room to cut its target for the federal funds rate, already lying at a 45-year low of 1 percent, he said.

  But the administration of President George W. Bush might find it difficult to get support from the opposition Democrats for another tax cut, especially with presidential elections due in November next year.

  Nevetheless, Lonski said the most likely economic outcome remained a gradual recovery, with quarterly economic growth averaging an annualized 3.5 percent in the second half of this year.

  Economic output next year was likely to be 3.6 percent above this year, he said, with relatively low rates of capacity utilization preventing a more robust performance.

  "Maybe there is really no need to panic but on the other hand, investors could be making a big mistake if they extrapolate too much economic vigor, too much improvement in corporate financial health from recent gains in economic activity," Lonski said.
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