The trm Report - November 2006

Trustee Risk Management
The Economic Landscape
Oliver Boyle

The economic picture emerging in the United States is strikingly different from that in Europe and the UK. Prices for new homes have recently experienced their largest yearly drop since 1970 and expectation is rising that the overall growth rate of the US will slow and reverse the rise in inflation. While in Europe and the UK the story remains a steadily rising pace of inflation.

The conventional view is that if the US economy slows down then it will only be a matter of time before the rest of the industrialised economies follow. Given the enormity of the US trade deficit this argument is compelling. However the sharp increase in the size of the Chinese economy over the past decade has lessened the importance of the US economy to the rest of the world. As a result, it might now be possible for the different economic blocs to sustain different rates of growth for longer.

Other countries have also become important sources of global demand such as India, Russia and importantly the Middle East. The oil producing economies are no longer simply re-cycling their financial reserves into financial assets (as was the case in the 1970s), but are investing in tangible assets, mainly infra structure. This is bolstering the global economy and will be an important source of durable growth in the years ahead.

The growth outlook for the US will therefore be the result of two countervailing forces. First, the economy is weakened by declining consumer demand due to the correction in the housing market. Second, the economy is supported by growth in the domestic industrial sector due to global growth. In other words, rather than slower US growth leading the rest of the world down the same path, it could be the case that the global economy supports US growth.

The US is at an important point in the five year economic upswing. If the pattern of world demand takes the usual course, then slower US growth will spread to the rest of the world and both interest rates and inflation will fall globally next year. However, if the industrialising and the Middle East economies have modified the usual relationship then the outlook for both US and global growth will be for acceleration into next year. The upward pressure on global inflation will intensify and the Federal Reserve will be following the Bank of England and have to raise rates when they might have thought they had finished tightening.

Economic forces of this magnitude will impact financial markets and possibly unbalance conventional thinking in certain markets. Interest rates and credit markets will need to be watched very carefully, particularly as pension funds lock themselves into long dated structured bond arrangements.

The temptation for trustees to seek a packaged liability driven solution is compelling. But, in doing so, trustees should be aware of the underlying economic forces at work. This is a very risky time to taking long term interest rate and credit decisions.

Oliver Boyle
Director of Business Development
Thomas Miller Investment Ltd
020 7204 2744
oliver.boyle@thomasmiller.com
www.tminvestment.com