Global Markets Weekly - 2nd February 2009
- Amid the deepening economic gloom, the IMF has slashed its growth forecasts.
Last week saw a continuation of the negative economic and company news which has defined 2009 so far. Confirming this difficult environment, the International Monetary Fund (IMF) severely downgraded its growth forecasts for all regions. Global growth in 2009 is now expected to be just +0.5%, described by the organisation as a virtual halt. Across the developed world, growth is predicted to be around –2% this year, with no country or region significantly bucking the trend. The UK economy is forecast to fare worst, shrinking by 2.8%.
- Typically, investors react cautiously to a recovery led by government spending.
Within the IMF’s apparently apocalyptic growth forecast is the implicit expectation that growth rates will probably be positive by the end of the year. That is in line with our own forecasts. However, we would caution that growth will be government-led – a result of the vast stimulus packages being discussed and enacted in various countries around the world. Investors’ response to public-sector-led growth is likely to differ from what we would expect in a more normal, ‘inventory rebound’ recovery. In particular, investors are likely to remain cautious until they see evidence that government-sponsored growth is gaining traction and becoming more self-sustaining.
- The risk of deflation is growing...
In the meantime, the global output gap is set to increase considerably, exerting powerful downward pressure on inflation . In economies that entered the downturn earliest, most significantly the US, this downward pressure on prices has now turned into the risk of a sustained period of deflation.
- ...which highlights the importance of quantitative easing.
We can use a simple Taylor Rule to translate the IMF’s growth and inflation forecasts into an appropriate policy interest rate for the US during 2009 . This suggests that the Federal Reserve (Fed) should set its target overnight rate at –2%. Of course, interest rates can’t be negative, so this finding emphasises the importance of the alternative policy measures the Fed is undertaking – i.e., easing monetary conditions further than is possible just by setting interest rates.
- Private-sector debt has risen steeply in the US and elsewhere...
Emerging Especially high levels of private-sector debt increase the need to combat deflation in the US and other highly geared economies, such as the UK and peripheral eurozone countries. In the US, we observe a long-standing upward trend in the ratio of private-sector debt to GDP, a result of the increasing financial depth of the US economy. From 1997, however, the growth of this ratio accelerated sharply (see chart over page).
- ...increasing the risks should a debt-deflation cycle set in.
This high level of debt is of course denominated in nominal terms. So, should deflation transfer to shrinking wages, debt repayment would become less affordable, and the economy could enter a debt-deflation spiral . This possibility explains the Fed’s dramatic quantitative easing measures and the fiscal stimulus package passed by Congress last week.
- ...leading
For that they consider China a ‘currency manipulator’ – which could have implications for trade agreements – adds unwelcome political risk to an already difficult situation.
- Inflation and bond yields are likely to remain low for some years.
Given the scale of the slowdown in growth, we believe that concerns about rising inflationary pressures are misplaced. Indeed, a glance at financial history shows that economies that have experienced deflation after a large build-up in debt see falling and then stable bond yields (and, by implication, inflation expectations) for several years. Although active monetary and fiscal policy may mitigate and shorten this process, a return to 1997-2007 levels of private-sector debt creation is not feasible in the foreseeable future.
- The world has changed.
As the new President of the US has adroitly observed, ‘The world has changed, and we must change with it.’
Indicies Rates and Prices
|
Close -30-Jan-09 |
1 Week% |
1 Month% |
3 Months% |
YTD
% |
|
FTSE ALL Share |
2,079 |
2.4 |
-5.2 |
-3.0 |
-32.8 |
|
FTSE 100 |
4,150 |
243 |
-5.5 |
-3.3 |
-31.3 |
|
S&P 500 |
826 |
-0.7 |
-7.3 |
-13.4 |
-38.5 |
|
Nasdaq Composite |
1,476 |
-0.1 |
-4.8 |
-13.1 |
-40.5 |
|
DJ Stoxx (Europe) |
207 |
4.2 |
-7.1 |
-10.6 |
-46.3 |
|
Nikkei 225 |
7,994 |
3.2 |
-9.8 |
-11.5 |
-42.1 |
|
Hang Seng |
13,278 |
5.6 |
-6.7 |
-7.3 |
-48.3 |
| Official Rates (%) |
Inflation (%) |
Rate announcement |
|
Current |
Mar-09 Forecast |
Jun-09
Forecast |
Current |
Next Date |
|
US (Fed Funds) |
0-0.25 |
0-0.25 |
0-0.25 |
0.1 |
17-Mar |
|
UK (Base rate) |
1.50 |
0.75 |
0.50 |
3.1 |
05-Feb |
|
Euro-zone (Repo Rate) |
2.00 |
2.00 |
1.75 |
1.6 |
05-Feb |
|
Japan (Call rate) |
0.10 |
0.10 |
0.10 |
0.2 |
19-Feb |
View the full Global Markets Weekly report (pdf).
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