Stabilisation of the global economy
May 4 2009 - There are further signs that the global economy is stabilising. The most recent set of data indicate that economic activity has stopped deteriorating at a rapid pace. This has given some encouragement to investors, who until recently were factoring in expectations of a severe recession that would just skirt becoming a depression. Now, they can interpret the evidence as pointing to merely a hard recession, with the likelihood of a rebound in sight.
An accompanying feature is the improvement registered in bond and credit markets. Short-term Libor rates are declining, as the interbank market begins to thaw. And closely watched measures such as the Libor-OIS and Ted spreads have been tightening. Yields on important bond indices covering riskier categories such as emerging markets and lower-grade corporates have fallen. The iTraxx Crossover index, which is a good measure of credit sentiment, indicating the cost to insure bonds against default, has also declined.
One worrying factor is that the Obama administration is still muddling along, rather than acting decisively, on the issue of bank stress tests. As of the first of May, there isn’t a whole lot of clarity about how it is going to be sorted out and what is going to be revealed. But there are hopes that more information will be forthcoming in coming weeks.
Some of the economic data is still weak, such as US personal income and spending, both of which fell more sharply than expected. But investors are in a more ebullient mood, willing to look past any bad news and focussing more on the positive data. Also, in this context, the outbreak of swine flu hasn’t roiled markets. The assumption is that officials are prone to exaggerate the possibility of a pandemic. From the authorities’ point of view, under-reacting carries greater political risks than overreacting.
Generally, consumer spending in the US and some other countries is showing a degree of resilience, undoubtedly helped by the impact of fiscal stimulus packages. An important consideration is whether household expenditures can grow autonomously once the effects of government stimuli begin to wane.
Naturally, the extent to which employment prospects improve will be important in determining the capability and willingness of consumers to spend more generously. Secondarily, stabilisation of house prices may help to shore up confidence. This is particularly true of countries such as the US and the UK which have suffered a housing crash. And we shouldn’t leave out the beneficial effect of rising stock markets.
But a turnaround in the job market will be slow, because firms have shown considerable zeal in cutting payrolls and may continue to do so if business conditions don’t improve. Corporations across the world have reacted to the decline in revenues by rationalising their operations and saving costs wherever possible. This is a sensible course of action for the individual firm, but damaging at the aggregate-economy level because of its multiplier effect in reducing demand.
The corporate efforts have paid off by limiting the extent of expected losses, as evidenced by recent earnings reports that generally surprised the market to the upside. In addition, of course, expectations had already been lowered before the reporting season began.
But now that the fat has been cut, further rationalisation may end up slicing off the bone and muscle that companies need if they are to succeed in a competitive marketplace when the economic rebound arrives. So in assessing the overall long-term competiveness of a company we need to watch out for mistakes in overzealous cost cutting that may hobble it in the future. The winners of tomorrow will come out of this recession lean, mean and ready to take market share in the next growth cycle.
Expectations of a global economic rebound in the second half of the year have risen. And it is important that there should be some confirmation of the expectations, in future data releases, to maintain a healthy level of business, investor and household confidence.
The evidence indicates that US households will be neither able nor willing to indulge in the excessive consumption habits of the past. On the positive side, this means that the global imbalance between the United States and Asia, showing up in large current account deficits and surpluses, may diminish. But on the negative side, it means that one of the major components of global aggregate demand will be less significant, even as there is no obvious compensating factor to fully take its place.
The implication is that, if for no other reason, overall global growth is likely to be constrained compared with the boom years until further adjustments and developments occur in a number of countries. There is also the issue of exit strategies from excessive fiscal and monetary policies that are going to be very challenging, to say the least.