Amid these gyrations, economic data were not a major focus, but results overall were a bit better than expected, which pressured Treasuries somewhat at times. Quite solid results for capital goods orders and shipments in the durables report partly offset by weaker-than-expected consumer spending data in the personal income report led us to raise our 3Q GDP forecast to +3.0% from +2.7%. Our 3Q estimate has been bouncing around between 2.5% and 3% for the past month-and-a-half, with upside supported by improved data in July and June. The trajectory after July heading into 4Q looks a lot more sluggish, but there were some at least mildly encouraging indications over the past week for the key initial round of September data that will be released in the coming week, with all four regional manufacturing surveys released through the week showing improvement ahead of Monday's ISM release, and the latest jobless clams figures potentially pointing to some improvement in labor market conditions in late September after what's expected to be a soft employment report based on conditions as of the mid-month survey period.
On the week, benchmark Treasury yields rose 4-12bp, with the belly of the curve underperforming. The old 2-year yield rose 4bp to 0.26%, 3-year 6bp to 0.42%, old 5-year 10bp to 0.95%, old 7-year 11bp to 1.43%, 10-year 12bp to 1.92%, and 30-year 5bp to 2.92%. TIPS ended mixed, with a sharp decline in short-end inflation breakevens, especially for some reason after the Fed's releases of the Treasury buying and selling schedule for October, 5-year breakevens rising moderately, 10-year breakevens little changed, and 30-year breakevens down moderately. This came amid a somewhat more mixed performance by commodity prices - the CRB fell 1.2% overall, with base metals down significantly and oil modestly but gasoline futures rebounding 1% from the prior week's steep decline - and the dollar after the sharp initial post-FOMC moves. The 5-year TIPS yield rose 5bp to -0.59%, 10-year 11bp to 0.16%, and 30-year 9bp to 1.03%. On net now since the close ahead of the FOMC announcement, the 30-year nominal yield is down 29bp but 30-year TIPS yield only 1bp, with almost all of the decline coming in inflation expectations, certainly not the mix so far the Fed is aiming for. For the 10-year the breakdown is worse, with the nominal yield is down 2bp, TIPS yield up 13bp, and benchmark inflation breakeven down 28bp. The initial post-FOMC moves in the MBS market have been a lot more positive in response to the Fed's reinvestment shift. There have been some bouts of underperformance in lower coupons during periods of elevated originations - clearly an economically benign cause of short-term market weakness - as MBS yields and mortgage rates have plunged to record lows, while higher coupons remain subject to investor sentiment on the prospects for a streamlined refi program, with some indications from Washington that progress is being made on HARP reform. But there has been a solid bid in current coupon MBS from a variety of investor types that has supported quite good performance when supply pressures haven't significant. For the week, Fannie 3.5s outperformed Treasuries by about 6 ticks and ended only slightly softer in absolute terms. Primary/secondary spreads remain wide, but the drop in current coupon MBS yields from near 3.20% at the close ahead of the FOMC announcement to near 3% currently pulled average 30-year mortgage rates to a record low of just above 4% in the latest week.
Data released the past week pointed to somewhat better growth in 3Q after the upward revision to 2Q GDP to +1.3% from +1.0%, with business investment looking much better than consumer spending. Underlying figures on capital goods orders and shipments in the durable goods report were surprisingly robust. Non-defense capital goods ex aircraft orders gained 1.1% in August on top of an upwardly revised July reading (-0.2% versus -0.9%), and shipments were stronger, with non-defense capital goods ex aircraft shipments surging 2.8% in August. On top of good upside in July (+0.4%) and June (+2.0%), this put equipment investment on a strong trajectory in 3Q. Also including some data in the GDP revision details showing stronger business spending on motor vehicles, we see business investment in equipment and software rising 12% in 3Q, up from our prior +7.5% estimate. On the other hand, the personal income report pointed to slightly more sluggish consumer spending. Real consumption was flat in August, which was a bit better than we expected, but this was offset by downward revisions to prior months. We now see consumption rising 1.3% in 3Q instead of +1.5%. Taken together, this boosted our 3Q GDP estimate to +3.0% from +2.7% coming into the week. Our 3Q estimate has been bouncing around between about 2.5% and 3% since our mid-August global forecast revisions. It's important to keep in mind, however, that the upside in 3Q growth largely reflects improvement in the economy in June and July, as supply chain disruptions eased and auto production ramped up and consumers received a boost from the pullback in gasoline prices from the May peak. The post-July trajectory of the economy looks notably softer, probably at this point pointing towards about 1.5% GDP growth in 4Q ahead of the potential for material fiscal tightening at the start of 1Q. Capital spending indicators holding up well into August was an encouraging sign though.
The upcoming week sees the initial run of key economic reports for September - manufacturing ISM and motor vehicle sales Monday, non-manufacturing ISM Wednesday, chain store sales reports Thursday, and the employment report Friday. Early indications for these releases seen over the past week were somewhat positive. The second round of key regional manufacturing surveys were all improved on an ISM-comparable weighted average basis - Dallas Fed (51.6 versus 50.6), Richmond Fed (48.8 versus 47.0), Kansas City Fed (52.8 versus 51.5), and the hard-to-believe Chicago PMI (60.4 versus 56.0). Combined with the softer Empire State and Philly Fed surveys released a couple of weeks ago, the average of the key early regional surveys on an ISM-comparable basis rose to 51.2 from 49.5. Based on the better results released over the past week, we raised our ISM forecast to 51.0 from 50.0 versus 50.6 in August. Meanwhile, jobless claims figures continue to show a significant deterioration from mid-August into the mid-September survey period for the employment report, pointing to another weak result. We forecast a 100,000 gain in non-farm payrolls and only +55,000 excluding strike impacts, and a 0.1pp rise in the unemployment rate to 9.2%. In explaining a 37,000 plunge in initial jobless claims in the week of September 27, past the survey week, to a nearly six-month low, however, the Labor Department said that elevated readings earlier in September appeared to be partly caused by temporary hurricane disruptions. If so, this could point to somewhat better employment results in October, and we'll be examining the details of the September report for indications of how much of the expected softness may be attributable to temporary disruptions versus underlying deterioration. On the early consumer spending indicators for September, initial industry reports pointed to a slight increase in motor vehicle sales, in line with our forecast for a rise to 12.3 million from 12.1 million. There may be upside risks to our estimate, however, with J.D. Power raising its estimate to 13.0 million Friday, saying its dealer surveys indicated that sales stayed strong through the month.
In addition to the data, while continuing to keep a close watch on developments in Europe, including the ECB meeting Thursday, domestic focus in the coming week will be on Fed Chairman Bernanke's testimony on the economic outlook to the Joint Economic Committee on Tuesday and the beginning of the implementation of the Fed's portfolio extension program. Chairman Bernanke made some brief comments on the US economic situation after a speech on emerging markets growth on Wednesday. His most notable remarks focused on downside risks to inflation and inflation expectations as a potential trigger for further Fed action. This seems quite unlikely to provide a near-term trigger, as core PCE inflation continued moving higher in August to +1.65%Y from +0.93% at the end of 2010. But clearly the Fed is not going to be concerned at this point about a further acceleration in core inflation in coming months, likely to slightly above its 1.7% to 2.0% long-term target by year-end, as focus remains on downside growth risks. If there is going to be a further ratcheting up of Fed easing, downside growth surprises, especially in the employment report, would be the likely trigger. The initial week of the Fed portfolio extension program sees buying in 2036-2041 maturities Monday, 2019-2021 Tuesday, TIPS Wednesday, and 2021-2031 Friday, and selling of securities in the January to July 2012 range Thursday.
Data releases due out in the coming week include manufacturing ISM, construction spending and motor vehicle sales Monday, factory orders Tuesday, and employment Friday:
* The second round of regional reports from Dallas, Richmond, Kansas City, and Chicago showed improvement after the mixed results in the Philly and Empire State surveys. As a result, we have raised our September ISM forecast a point to 51.0, which would reverse the dip to 50.6 in August. This would still point to much more sluggish growth in manufacturing sector activity than seen in the first half of the year, as the same factors that are negatively impacting consumer confidence - particularly, dissatisfaction with government economic policy - appear to be triggering some deterioration in business sentiment.
* We forecast a 0.3% gain in August construction spending. The number of homes under construction edged down a bit in August, so we may see some slippage in the new home construction category. However, the volatile home improvements category is expected to register a modest rebound. Commercial construction is also expected to post a gain in line with the underlying trend in recent months. Finally, the public sector should continue to slide as support from federal fiscal stimulus has faded.
* We look for September motor vehicle sales of 12.3 million units annualized, as industry reports suggest that the sales pace will edge up slightly relative to the 12.1 million unit pace posted in August. The gain is expected to be concentrated in the light truck category.
* We forecast a 0.9% decline in August factory orders. Overall durable goods orders dipped 0.1% on a pullback in motor vehicles and a drop in the volatile defense capital goods category, but core capital goods orders were much stronger, rising 1.1%. Non-durable goods orders are likely to see some significant price-related weakness, adding to the dip in the durables component.
* We forecast a 100,000 gain in September non-farm payrolls. Jobless claims showed some modest deterioration on a survey week-to-survey week basis, so we look for a sluggish rise in employment. Indeed, the return of 45,000 Verizon workers, who were on strike in August, accounts for nearly half of the anticipated payroll gain. Also, the unemployment rate is expected to tick up by 0.1pp this month to 9.2%. In general, employers seem to have turned more cautious in the wake of the debt ceiling debacle. Indeed, surveys show that the public's dissatisfaction with government economic policy is at its highest level in decades. However, The Labor Department indicated in the latest jobless claims report that hurricane disruptions may have been a significant drag on job growth in September, so we will be looking in the details of the report for any indications of a material weather impact.
At Least a 50-50 Chance QE Resumes in November
The vote on quantitative easing (QE) at the September meeting remained 8-1, but the tone of the minutes signalled an increased likelihood that the Bank of England (BoE) will resume asset purchases over the coming months. According to the minutes, "For most members, the decision of whether to embark on further monetary easing at this meeting was finely balanced since the weakness and stresses of the past month had significantly strengthened the case for an immediate resumption of asset purchases". Moreover, "Most of these members (read: apart from Adam Posen) thought that it was increasingly probable that further asset purchases to loosen monetary conditions would become warranted at some point."
We think there is at least a 50-50 chance that QE resumes in November, with a significant risk of an October move. Some members suggested that "a continuation of the conditions seen over the past month would probably be sufficient to justify an expansion of the asset purchase programme at a subsequent meeting". In light of the bearish economic and market newsflow over recent weeks, we suspect that the vote could be 6-3 or even 5-4 at the October meeting.
By November, much will hinge on developments in the eurozone and in the domestic economic data (particularly the business confidence surveys). At the current juncture, our European Economics team believes we are some way from a comprehensive solution to the crisis; hence, the negative feedback loop should continue to buffet the UK banking sector and economy. While statistical effects should flatter 3Q GDP growth (2Q GDP was artificially depressed by the fallout from Japan and the loss of a working day for the Royal Wedding), the underlying picture is much more subdued. The latest Purchasing Mangers surveys are pointing to very little growth at the present time, and the more forward-looking components point to further weakening. As a result, we are downgrading our GDP forecasts to 1% for 2011 and 1.1% for 2012.
Set against this deteriorating backdrop (and given the recent pullback in commodity price futures), in its November Inflation Report the BoE may forecast a decent (although not huge) undershooting of inflation at its two-year time horizon, assuming unchanged interest rates (on the same basis in August it forecast inflation around the target level, but it now expects materially weaker second half growth). This, together with the growing uncertainty and downside risks around the economic outlook, should be enough to persuade a majority of members to vote for asset purchases, with £50 billion the most likely amount. Recent speeches from policy-makers suggest that they will be primarily targeted at longer maturities. As a result of the increased likelihood of doing QE, we have pushed our rate hike forecast to February 2013 at the earliest.
That said, we are not totally convinced that QE is a done deal just yet. With inflation likely to rise towards 5% in October, a number of members remain concerned about easing policy during a sustained period of above-target inflation and amid concerns over how quickly it will fall back. These fears will not have been assuaged by recent Financial Times analysis, using the Office for Budget Responsibility's (OBR) methodology, which suggested the economy's spare capacity may be significantly less than the OBR previously forecast. Recent speeches from MPC members Dale and Broadbent suggesting that the economy's trend growth may be lower than previously thought will have reinforced this message. Meanwhile, the BoE's own analysis in the 3Q Quarterly Bulletin suggests that the impact on inflation from further QE is not insignificant. So, it is not totally inconceivable that if, by the end of October, European policy-makers have confounded expectations and started to get a grip on the situation, the MPC (if growth was soft but not collapsing) may wish to eschew further easing, allowing time to assess developments in the global economy.
We Don't Think QE Will Be Much of a Panacea
While we think that, on balance, QE will be beneficial to the economy, we are somewhat less sanguine about its impact than the BoE. In its 3Q Quarterly Bulletin, it discusses the design, operation and impact of QE, with the range of estimates for GDP and inflation under different modeling methods.
Below we list the main mechanisms through which the BoE suggests that asset purchases will boost the economy, and we discuss the likely efficacy of each.
Policy signaling effects: With markets already expecting no change in interest rates until mid-2013 at the earliest, one suspects that there is little potential further boost from this channel - Governor Mervyn King said as much in the Q&A after the August Inflation Report. In response to a question on whether the BoE could mimic the Fed in signaling that rates are likely to remain low over the next couple of years, he suggested that market interest rates in 2013 were almost unchanged from where they are now, despite the lack of a commitment.
Portfolio balance effects: Undoubtedly, there is some scope to still boost the economy, but much less than in 2009, in our opinion. Yields are significantly lower than in 2009, across all parts of the curve. Lately, some MPC members have made the case that longer-maturity yields are not at historical lows, but they are still at incredibly stimulative levels. Moreover, in addition to reducing yields on the assets it buys, the BoE hopes that the sellers (preferably non-bank financial institutions) will use the funds to invest in riskier assets like corporate bonds and equities, reducing their risk premia. Towards the longer end of the curve, pension funds and insurance companies are significant owners of gilts, given their desire to match their long-term liabilities. Given the increased uncertainty and weakening economic outlook and the failure of the last round of QE to promote a sustainable recovery, one could seriously question the current appetite among these institutions to move up the risk curve into equities and corporate bonds.
Confidence effects: The theory behind the life-cycle hypothesis of consumption suggests that if consumers believe they have a permanent increase in wealth, they will increase current consumption. The failure of QE to deliver last time further increases the risk that consumers view any increase in asset prices as fleeting, disappearing once policy-makers pull away the punchbowl. It would be extremely surprising if businesses weren't equally sceptical.
Liquidity premia effects: When financial markets are dysfunctional, central bank asset purchases can improve market functioning by increasing liquidity through actively encouraging trading. Asset prices therefore increase through lower premia for liquidity. Evidence from Japan, the UK and US certainly supports the efficacy of this type of intervention. However, at the current juncture, the UK's asset markets are not particularly dysfunctional, and where there are problems these are emanating from the eurozone.
Bank lending effects: By purchasing assets from non-banks, the BoE injects monetary base into the financial system, and these extra funds should end up in deposits at the commercial banks. Under normal circumstances, this would typically spur a surge in lending to households and corporates and subsequent gains in broader measures of money. However, the money multiplier (broad money/monetary base) is currently impaired, primarily due to an elevated desired reserve ratio among the banks (desired reserve ratio = [required reserves + excess reserves]/deposits). A number of well publicised factors are currently making banks refrain from lending (and accumulate excess reserves), and these factors are unlikely to abate in the foreseeable future. Admittedly, though, the BoE has never been particularly optimistic about the efficacy of this channel in recent years either.
Meanwhile, the factors likely to reduce the efficacy of the different mechanisms described above suggest that the benefits from a US-style Operation Twist would also be quite limited (at the September meeting, the BoE suggested that further asset purchases were preferred at the current juncture).
Another Round of QE Poses Significant Risks to BoE Credibility
There has been a drumbeat of support recently from government officials and some business leaders for the BoE to resume QE. Given the coalition government's fiscal mandates, it may have very little wiggle room to ease discretionary fiscal policy to bolster growth. Indeed, the risk is that intentional fiscal slippage could undermine its fiscal credibility and fuel a sharp jump in borrowing costs. Hence, the onus falls on the monetary authorities to support the economy at the present time. However, we believe that one should not underestimate the risks posed to the BoE's own credibility by embarking on another round of QE. In a recent speech, MPC member Ben Broadbent suggested that, while the UK inflation-targeting regime looked robust, "That's clearly not something that can, or should, be taken for granted. Credibility is earned, over time, by keeping inflation close to its target".
Strikingly, the BoE would be the first of the major developed central banks to start injecting money back into the economy (unsterilised), despite the UK having much higher inflation than its peers. When the MPC initiated QE in March 2009, inflation stood at 2.9%, and there had been a complete collapse in the outlook for growth and consumer prices. In contrast, inflation is likely to reach 5% in the coming months and the growth slowdown has not yet been dramatic. Any further policy-induced weakening in the currency would fuel further upward pressure on inflation.
In our opinion, much of the perceived ‘safe haven' status of the UK during the recent financial crisis has been due to investor confidence in a combination of the country's fiscal and monetary policies. The risk is that, thinking in terms of the simplistic Uncovered Interest Rate Parity model, foreign investors may begin to demand higher interest rates to compensate for fears of further sterling depreciation. We have already seen a sharp decline in net gilt purchases by foreigners in the last couple of months (they turned net sellers in August). These data can often be quite volatile, so one should not read too much into it just yet, but it certainly suggests to us that policy-makers should proceed with caution.
Policies to Reduce the Lending Spread Would Be Most Effective, but They Are Unlikely at the Current Juncture
The key problem for the economy is the large spread of effective lending rates to households and corporates over the Bank Rate and the lack of provision of credit to key areas of the economy, such as SMEs and first-time homebuyers. The lending spread has increased sharply since the onset of the financial crisis (and this understates the true spread as it excludes all those that have been refused loans).
In its August Inflation Report, the BoE highlighted the two key components of the lending spread, the rise in the cost of bank funding relative to the Bank Rate and the spread that banks add over their funding costs (reflecting a wide range of factors, such as credit risk charges to cover possible loan losses, lenders' mark-up, etc.). A rise in the latter component (particularly for certain borrowers) was unsurprising, after the lax lending standards of the preceding years.
The main problem in terms of credit provision, however, is the former. Moreover, the ongoing crisis in the eurozone is exacerbating the banks' funding problems. Since the beginning of August, credit default swap premia (the cost of insurance against default for bondholders) for the major UK lenders have absolutely soared, signaling a further rise in the banks' cost of funds and the future rates at which they lend to the wider economy.
In our opinion, increased gilt purchases by the BoE will do little to ameliorate this (even if they were of considerable size). We think that, in order to reduce the spread or to provide more lending to SMEs, the monetary authorities may at some point have to consider more aggressive quasi-fiscal-type measures. Adam Posen, in particular, has suggested a number of different schemes. We certainly don't think that the BoE is there yet. However, if there was a significant blow-up in the eurozone or the UK looked to be entering a more prolonged downturn, we believe that the BoE may consider them under instruction from the government. We will discuss some of the potential quasi-fiscal type measures the authorities may consider employing in a forthcoming publication.
The recent turmoil in global market has coincided with the emergence of mounting signs of weakness in the Mexican economy. After exhibiting a fair bit of resilience through July, the latest batch of data signal a more material downshift in the pace of economic activity, consistent with the deterioration observed in several leading indicators in Mexico and its main trading partners (see "Dangerously Close to Recession", This Week in Latin America, August 22, 2011). A stronger balance sheet means that Mexico is in better shape than in the past to deal with the ongoing market turmoil (see "Brazil and Mexico: Is it Different this Time?" This Week in Latin America, August 15, 2011). Still, the deterioration in global growth prospects seems to be already leaving its mark on Mexico's decelerating growth dynamic - even before any potential negative spillover on confidence from recent market jitters - echoing the warning contained in the central bank's last statement of rising risks that could "adversely affect" the future performance of economic activity.
The Writing on the Wall
Even before the weak batch of August reports, a series of leading indicators were suggesting that an imminent slowdown was on the cards. The first warning sign came in the form of the sharp decline in the IMEF manufacturing diffusion index to 50.6 points in July, which though still above the critical 50 threshold was the lowest print since the economy turned in mid-2009 once adjusted for seasonal factors. With the link between Mexico and the US at the industrial front alive and well, the weak July IMEF reading mirrored a very disappointing ISM report, which had been released just two days earlier (see Economic Data Bulletin: ISM (July), August 1, 2011). A similar survey by Mexico's statistical institute, INEGI, held up surprisingly well in July, only to drop sharply in August to a 10-month low with weakness in key components like hiring and capex plans as well as orders. And though the non-manufacturing IMEF has been more resilient (52.5 points in August), this provides only limited room for comfort as further deterioration in the external picture should eventually translate into softer domestic demand conditions, in our view (see, for example, "Mexico: Capex Unsqueezed", This Week in Latin America, March 29, 2011).
The deterioration seen in industrial surveys can also be found in broader indicators. The Conference Board's leading index has been down in three of the past six months, leading to a meaningful deceleration in the key six-month trend to just 2.2% annualised. Importantly, this slowdown has coincided with a broadening in the weakness among the index's various components, suggesting that the economy is likely to continue expanding but at a more subdued pace. The leading economic indicator from INEGI, meanwhile, has pulled back in each of the past three months, hinting at a potential shift in trend.
Shifting into Lower Gear
The disappointing message from leading indicators can now be seen in hard data as well. After an encouraging performance in July - when the economy posted a strong 0.9% sequential gain led by primary sectors, according to the GPP-proxy IGAE - most reports from August have come on the soft side. Against this backdrop, the central bank is likely to downgrade further its assessment of the economy when it meets in October 14, in our view. After all, the most recent August statement, the authorities indicated that the economy had only lost "some dynamism" while pointing out that "exports remained vigorous".
Mexico's manufacturing complex - which for most of the past two years has been the economy's most dynamic sector - has shifted into lower gear. The slowdown may not seem obvious from looking at aggregate manufacturing, which rose sequentially in three of the past four months at an average annualised clip of over 6%. However, once we exclude the automobile sector, the picture changes dramatically: manufacturing ex-autos has turned down in excess of 2% annualised between May and July, according to our calculations, and has gone virtually nowhere in the past six months. While part of the softness may be related to part shortages from Japan, the fact that manufacturing ex-autos has failed to rebound - as the automobile sector did - in the past couple of months suggests that there may be more than just temporary factors at play.
Industrial exports, meanwhile, declined in August at the fastest sequential pace since late 2008, according to data from INEGI. While part of the pullback may have be related to payback from July's strong gain, when exports reached a historically high level, the decline is consistent with the trend in the ISM export orders, which tends to lead Mexican exports.
The deterioration in external demand seems to be in part behind the poor set of labour market figures of late. The economy added formal jobs in August at the weakest pace - to the tune of 1.4% annualised - since the recovery began in mid-2009. Tradable sectors, led by manufacturing, actually shed formal jobs in August; meanwhile, hiring in non-tradable (services) sectors rose 2.5% annualised, nearly one full percentage point slower than the average pace between January and July. The broader employment survey by INEGI has shown a gradual rise in the seasonally adjusted rate of unemployment in recent months, as well as in under-employment, to the highest level since late 2010. While historically quite volatile, August's jump in the unemployment rate came amid a sequential decline in labour participation, suggesting true underlying deterioration in labour markets. Indeed, we've argued that lingering slack in labour markets is one of the factors that should allow the central bank to cut interest rates by year-end (see "Mexico: Room to Ease", This Week in Latin America, September 19, 2011). While the Mexican peso's sharp sell-off and recent volatility make a rate cut at the October 14 meeting unlikely, we still expect a rate cut by year-end.
And softening job markets may be starting to show up in retail sales figures: Though sales have maintained their moderate uptrend, July's gain (+0.4% sequential) was relatively modest considering widespread promotion during the month. And while the narrower survey by retail chamber ANTAD showed positive growth in August, the pace was slower than in June and July. Moreover, imports of consumer goods excluding gasoline flattened out, possibly indicating more subdued consumer demand. Imports of capital goods, which are a proxy for machinery and equipment investment, have been more resilient, though the recent decline in capacity utilisation as well as market jitters should lead to a deceleration ahead (see "Mexico: Capex Unsqueezed", This Week in Latin America, March 29, 2011).
Looking ahead, more broad-based signs of deceleration are likely to become apparent, in our view, consistent with our below-consensus forecast for growth in both 2011 and 2012 (see "Latin America: Abundance Shaken", This Week in Latin America, August 23, 2011). After all, available data have yet to reflect the potential negative spillovers from September's sharp depreciation in the exchange rate and decline in asset prices, which is likely to dent business and consumer confidence as well.
Bottom Line
Even before the recent market turmoil led to a string of downgrades in growth estimates for Mexico, Mexico's link with the US has meant that the slowdown is well underway. With weak incoming data - ranging from industrial output and exports to labour market indicators - confirming that the pace of economic activity is cooling off, Banco de Mexico is likely to find room to ease rates before the end of the year.
The risks of a global recession appear to be rising - as evidenced by continued market declines - and we suspect that no country in Latin America is likely to be immune. Indeed, while strong balance sheets among most economies in the region are likely to prevent a global recession from turning into economic crisis, a more pronounced slowing (or reversal) in global growth may result in softening commodity prices and a cyclical downturn in economic growth (see "Latin America: Abundance Shaken", This Week in Latin America, August 22, 2011). But while none is likely to be immune to the cyclical downturn, we suspect that policy-makers in some countries may have significant firepower to counter the global growth headwinds. In particular, if the global economy does slip into recession, we expect Colombia's policy-makers to be in better shape to mitigate the fallout along three dimensions.
Solid Balance Sheet
First, a solid balance sheet should help policy-makers to counter currency stress. Indeed, Colombia has two fundamental strengths to mitigate an external shock: a solid international reserve cushion and a sustainable current account.
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