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S. Balakrishnan

ANOTHER meeting of the US Fed is getting under way as this is being written. The news coming out of the economy and markets, as they sit to decide their interest rate stance, is anything but positive.

Out of four pieces of data released in the last week or so, only one — retail sales — was encouraging. Consumer confidence slid as did industrial production. The index of leading indicators released on Monday was negative for the third month in a row. As for the stock markets, the Dow dropped below 8,000. The Nasdaq breached 1,200. At this rate, as one analyst forecast some weeks back, 1,000 is not too far away.

The fear is that the erosion in the economy and markets will, sooner or later, spill over to the consumer.

Housing, for example, has shown tremendous resilience so far mainly because of historically low interest rates. But even this sector has slipped a bit in the latest figures.

Oil prices have surged in reaction to the prospect of a US-Iraq war. There was a slight blip in the consumer price index, which showed a 0.3 per cent month-to-month increase both at the gross and ex-energy/food levels.

The US Government's budgetary surplus has vanished in just a year and the prognosis is for deficits to continue for several years into the future.

Clearly, it is an entirely new ball game. The economy is struggling to hold its head above water, markets are in the red, and deflation is on the horizon, despite rising commodity prices and worsening Government finances.

What are the possible consequences of war? The immediate impact will be on oil prices, which have already responded ominously to the tense situation between the US and Iraq. Indeed, a recent article in The New York Times speculates that, in a worst case scenario, almost 50 per cent of West Asia's oil output could be affected leading to skyrocketing prices. This is apart from changes in the long-term political equations in volatile countries such as Saudi Arabia, which will have far-reaching implications for global security and peace. It is these fears which seem to have spooked markets.

The Fed is likely to adopt a wait and watch policy. Interest rates should remain on hold with silver bullets kept in store if things get really nasty. Uncertainty will continue to plague the markets till the war clouds go and the US decisively ends the Saddam Hussein regime.

Bonds are already at record low yield with 2-year notes at 1.9 per cent, 5-year notes below 3 per cent and 10 years hovering around 3.7 per cent. They have been the biggest beneficiaries of war fears.

Time perhaps to sell?

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