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ECONOMIC PERSPECTIVE
Prepared by Merrill Lynch & Co.
Global Securities Research & Economics Group
Greenspan's Point Comes Home
The stock market plunge, correlated, if not precipitated, in part by rather severe falls in a number of emerging markets, has brought home to investors a point that Greenspan often makes, but which seems at times to fall on deaf ears. The markets involve risk!
The quick recovery brought a sigh of relief to investors but as this is written, it is not clear that the market is out of the woods. However, the immediate prospects for a 1987 style plunge appear to have been avoided.
The Best News On Inflation May Be Over
Our previous concern that the best news on inflation was past, but that a lack of pricing power in some industries would mitigate any rise in inflation. We see no reason to abandon this notion but, directionally, the stock market correction will make consumer demand less that it otherwise would have been, giving still less pricing power to some businesses. Further, the slowing Asian economies will lessen any upward pressure on commodity prices, also mitigating a tendency for inflation to rise.
While the dollar has recently backed up a bit against Eurocurrencies and the yen, it has been rising rather sharply against the currencies of many Asian countries that supply the U.S. with consumer goods and this too will help to hold prices down. Finally, one of the causes of the recent currency and stock market crisis in emerging Asian nations has been too much investment too quickly, and the increase in available production facilities will contribute to fierce competition.
All in all, then, our conclusion is that while inflation may stop falling, and while labor prices may increase a bit faster, the recent stock market correction is likely to lessen any increase in the inflation rate.
Asian Problems Will Shave U.S. GDP Growth
As for growth, the problems in Asia alone will act to slow export growth in such a way as to dampen overall U.S. growth (and unfortunately, to lead to an even bigger net trade deficit in 1998). Our Chief economist, Bruce Steinberg, estimates that the Asian crisis will shave 1/2% off U.S. growth in 1998. Further, if the stock market correction is, say, 15 to 25 percent, that too could negatively impact on consumer confidence going forward. It is important to keep in perspective, however, that a 25 percent correction in the S&P would still leave it unchanged for the year.
In light of the above market factors the Federal Reserve is likely to leave interest rates unchanged at their November 12 meeting. In retrospect the stock market correction, however far it gets may look rather normal. However, the fall on October 27 reminded observers that markets can be disruptive at times. Thus, even if the Fed might like to snug up rates a bit to fight potential wage pressures, it will prudently leave rates alone for the time being. And if the economy slows enough over the next couple quarters it will even consider easing.
October 30, 1997David Horner
Merrill Lynch & Co.
Global Securities Research & Economics Group
North Tower, 21st Floor
World Financial Center, New York, New York
Copyright 1997, by Consensus Inc. All American and Pan American rights Reserved. editor@consensus-inc.com
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