Fed rate action commentary from Swiss Re Chief US economist

31 October 2007, New York

After today's decision by the Federal Reserve to lower the target fed funds rate 25 basis points to 4.5%, Swiss Re's Chief US economist, Kurt Karl, commented, "The Federal Reserve Board has made a second, but more modest, move to alleviate the market turmoil. Since the market was hoping for 50 bp, it is unclear if this will provide sufficient liquidity to reduce market turbulence. At this time, the risk of recession over the next 12 months is 40% and rising due to the weak growth, market turmoil and elevated oil prices. Slow growth should lower inflation further, so the Fed should have few concerns about inflation and is expected to continue cutting rates."


"The September US housing permits and starts report precludes any optimism about a near-term improvement in residential construction — housing starts will decline for at least another four quarters. The credit crunch is expected to last through year-end, if not longer, and oil prices show no signs of falling significantly. The weak dollar, which boosts US exports, is also pushing up the price of oil by keeping it inexpensive in euros, yen and yuan. Any recession is still expected to be short and shallow, since inventories and capital equipment, outside of the housing sector, are not excessive. Equity markets, which are not highly overvalue, would rebound quickly, but will remain volatile in the interim. Credit markets will also be volatile and a slow sell-off can be expected. This could well be the last Fed cut, assuming the economy continues to muddle along. In our baseline forecast, this supports real GDP growth of 1.5% to 2.5% next year, and the yield on the 10-year Treasury note will be close to 4.4% by end-2007, rising to 4.7% by end-2008 as the economy strengthens. The US could still have a recession, with real GDP growth of about 1% next year and much lower interest rates," Karl said.

"Global growth has weakened, but there are no signs of recession outside the US. Growth in Europe and Japan is slowing. The weakness in the US, the credit market turmoil, and their strong currencies are softening demand, reducing growth. Inflation pressures in the UK are easing rapidly so the Bank of England is expected to cut rates twice, by 50 basis points in total, in the coming quarters. The ECB is expected to cut rates once when it is clear how weak the economy is, probably by end of 2008Q1, at the latest. Japan's growth is slowing and its inflation low to negative, so the Bank of Japan will delay its next rate hike into next year. It is still expected to raise rates next year but now only to 1.00% by end-2008. China continues to boom, so is expected to allow the renminbi to appreciate by about 6% per year, which will help to slow growth and lower inflation. Inflation and a possible hard-landing continue to be rising concerns in China. The US dollar has depreciated against the euro, pound and Canadian dollar about as far as expected. However, it will continue to depreciate against the yen, yuan and other Asian currencies. Since oil demand is being driven by Asia, this implies no near-term relief on high oil prices," added Karl.

Notes to editors

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