Global Economics

US

The US economic recovery has spread to the broader economy. Companies are now responding to the stronger growth environment by increasing capital expenditure and hiring new staff: over one million new jobs have been created in the last four months. Even the reluctant manufacturing sector is responding. Total employee compensation is rising strongly, a combination of higher wages and improved benefits (e.g., healthcare and pension contributions). We forecast 2004 growth of 4.7% and rising core inflation - enough to prompt the Federal Reserve to raise interest rates at the end of the month. This improving outlook poses a renewed threat to the current account deficit, which is now likely to expand further. And although tax revenues are growing as the economy expands, the budget deficit will peak in this fiscal year; government spending will only be addressed once November's elections have passed.

In the near term, the US dollar may benefit from rising interest rates; however, we are less sanguine about its longer-term prospects. Only increased foreign investment into US equities, which reduces the reliance on debt financing, should fuel a sustained currency appreciation.

The Federal Reserve left interest rates unchanged at 1.00% in May, but changed the wording in its statement: it said interest rates would only have to rise at a 'measured' pace, thanks to tame inflationary pressures and idle capacity. More recently, however, in the wake of stronger-than-expected economic data, Fed chairman Alan Greenspan suggested it might be necessary to accelerate the pace of rate increases. With interest rates a long way from neutral, an eventual doubling of interest rates from current levels would be only a small step in that direction.

EUROPE

European growth is only expected to reach 1.5% in 2004. Poor demographic trends, persistent unemployment and accelerating inflation (mainly through higher commodity prices) are unlikely to revive consumer spending. Stronger global growth is boosting export volumes and prices, despite the stronger euro. The European Central Bank is determined to keep monetary policy relatively tight, claiming that the region's economy will recover gradually in the second half of the year; it has also cited higher energy prices as a potential risk to inflation.

UK

The UK economy is expected to grow by 3.5% this year, a marked improvement over 2003 and the fastest annual rate in almost four years. The Bank of England's Monetary Policy Committee last raised interest rates by 0.25% to 4.25% in early May, although investors were surprised to learn it had debated a 0.5% increase in order to shock profligate consumers. Short sterling futures now anticipate a peak in rates of 5.70% in 2005, close to 1.50% above the current base rate.

With market participants having raised their growth forecasts for 2004, our own 3.5% figure is now only marginally above consensus. Consumers have continued to borrow and spend, their confidence buoyed by more than rising house prices and low unemployment: wages and salaries are now rising at a faster rate than last year. This will make it harder for the Bank of England to restrain consumer spending.

JAPAN

Japan is now the fastest growing economy in the G7, as key government policies - low interest rates, intervention in the currency markets (to halt the yen's appreciation) and financial system stability - appear to be having the desired effect. Global demand has fuelled export growth, while rising incomes and an ageing population (which spends more and saves less) are boosting domestic demand. However, China - Japan's second-largest export market - has recently introduced measures to slow down growth, which could dent future orders.

Expressing greater confidence in the country's economic prospects, officials have begun to prepare investors for an end to quantitative easing and the zero interest rate policy. However, many foreign investors remain sceptical of the recovery, believing this is yet another short-lived cyclical recovery. The Bank of Japan, keen to avoid repeating its previous mistake of tightening monetary policy too early and thwarting the economy's recovery, is willing to be patient. We are optimistic about the economy's immediate prospects, but retain some concerns about sustainability over the longer term.

Market Outlook and Portfolio Strategy for the Singapore authorised Henderson Global Bond Fund

CURRENCIES

PPP-based valuation frameworks highlight the richness of sterling and the cheapness of Canadian dollars relative to the US currency. On the same basis, the Japanese yen and the euro are both fairly valued. Any period of US dollar strength may prove limited unless the country's fiscal and current account deficits are reined in. In the relative absence of strong valuation signals, market dynamics come into play. Currencies of countries that were the first to raise interest rates in the current cycle (NZ, Australia and the UK) are being viewed as vulnerable. Property markets in all three are exhibiting 'bubble' characteristics: Australia's property market appears to have already burst, and the UK is very likely to follow suit.

GOVT BONDS

From a geographic perspective, we still favour Europe, where the economic outlook is relatively subdued. The Australian market is attractive, as higher interest rates have successfully slowed down the housing market and consumer spending. However, the high cost of currency hedging, and recent relative outperformance, demands some caution.

In June, we retained our short duration strategies in the US, UK and Japan: bond yields should continue to rise over the medium term in response to improving economic data and rising interest rates. In Europe, where growth prospects are relatively weak, we retained a neutral duration strategy.

Tim Swadling Investment Director,
Fixed Interest
Henderson Global Investors (Singapore) Limited