Economics Weekly - 5 October 2009 Is the world economic recovery faltering? Weekly economic data preview - Weak US data raise concerns the recovery is faltering
Economics Weekly - 5
Is the world economic
It would be nice and
easy to believe that the road to economic recovery is now clear and straightforward
after the financial market crash of 2007-2009. Equity markets have had one ofthe best quarters ever, corporate and
government bond yields have fallen sharply and spreads, in cash and corporate
bonds, are narrower than at any time since the crisis gathered momentum in 2008.
Economic growth has resumed in Q2 or Q3 of 2009 for most economies after a year
of declines. Housing markets (US, UK, Spain, Ireland) are seeing a
flattening in activity after the sharp falls of the past year or some modest
up-tick. And manufacturing output is recovering from its lows in most
countries. But there are some signs that the pace of the recovery is losing
momentum and faltering. We look at some of these issues in this Weekly Report,
starting with recent trends in financial markets.
How sustainable is the
recovery in financial markets?
Financial markets have
recovered but remain supported by record low interest rates and by money market
operations of central banks that are offering liquidity virtually free. This is
allowing banks to recapitalise, as lending spreads are still wide. Balance
sheet restructuring is therefore going on â that is to say, reduction of liabilities and raising
of new capital (some via equity issuance or bond issuance into stronger
markets) â but still appears to have some way to go. One way of assessing this
is that not all of the institutions that received public sector injections of
capital have yet been able to pay it back. In addition, credit conditions are
improving for businesses but spreads are wider and conditions attached to loans
are tougher than at any time over the last decade.
Of course, financial
market conditions are infinitely better than they were six months or a year ago
but a clear and unambiguous path to recovery is not yet assured. The true test
for financial markets will come when public sector support starts to be
withdrawn, and private flows of funds have to replace central bank capital. Looking
at the recent trends in manufacturing and other economic activity, however,
gives us reason to think that this process will not be smooth nor should be
undertaken too soon.
What about the recovery
in economic activity?
There have been some
tentative signs in recent weeks that the global economic recovery may not be advancing
quite as strongly as the financial markets have been expecting. In the US and UK, manufacturing purchasing
managersâ indices (PMI) posted a surprise fall in September. The weakness of
these reports lends weight to the worry that the pick-up in developed countriesâ
manufacturing activity in recent months may owe more to the
inventory cycle - and a reflux from the deep destocking that has occurred - and temporary car sale
inducements, rather than any underlying and as yet sustainable fundamental improvement
in final demand from consumers. Admittedly, in the Eurozone the manufacturing
PMI posted a slightly stronger-than-expected rise in September although, at
49.6, it remains below the 50.0 level separating expansion from contraction. In
some ways, Septemberâs weaker-than-expected PMI surveys are a useful reminder
that âall that glitters may not be goldâ in the manufacturing sector. Having
indicated modest expansion in July after five consecutive monthly improvements,
the latest PMI surveys may be a reality check in termsof firmsâ inventory cycle. We may well be
over the worst of the economic downturn, but there is not yet a compelling case
for stockbuilding given the ongoing fragility of demand.
Overall, the emerging
economies PMIs are showing that the recovery in manufacturing output levels is
more vigorous from a higher trough than in the developed economies, see chart
a. Highlighting this point is chart b, showing that PMIs in China and Singapore
are well above those of the global average. In contrast, the PMIs in the US, UK and euro area are
below the global average, and are showing stabilisation in output (near 50)
rather than that any sustained rise is underway (above 50). Even the PMIs for
services in the developed economies are little better - suggesting
stabilisation and modest expansions rather than strong upturns. Recovery is
occurring from the very depressed levels that private sector demand for
consumer durables, housing, stocks and capital fell to. However, our view is
that the after-effects of the financial market crisis and a desire amongst
households and businesses to reduce debt will keep the recovery below the rates
of expansion observed after previous downturns. Indeed, this is shown in the
history of US recoveries from recession, with the consensus suggestion that the
recovery after this downturn will be the weakest of any recession since the
1970s downturn, see chart c. Hence, the path to recovery in the US economy in the second
half of this year and next, will be modest and potentially volatile.
Latest US economic data not
encouraging for the pace of global economic recovery next yearâŚ
Latest economic data
from the US seem to back up the
view that economic recovery remains fragile at best. There was a plethora of
disappointing US economic data last week (ADP employment data, Chicago PMI, ISM
manufacturing). Finally, the September payroll numbers were very weak, -263k in
September, versus a consensus estimate of around -175k. The unemployment rate,
meanwhile, rose to 9.8% (in line with consensus) from 9.7% in August. Average
hourly earnings increased just 0.1% during September, softer-than- anticipated
by the market, chiming with the Fedâs statement in September which referred to âsluggish income growthâ. Labour
market conditions typically lag the GDP cycle, suggesting that the US economy is likely to
strengthen only gradually in 2010. But the table shows that the US will still be the best
performing of the major economies. Only the emerging countries will exceed its
rate of growth, modest though it may be. Unsurprisingly, higher unemployment is
probably the single biggest threat to a revival in global consumer activity. In
countries such as Germany, this adjustment could
be particularly sharp because, to date, government wage subsidies have led to a
slower pace of labour market deterioration compared with other countries, see
chart d. In the US, the labour market
adjustment has been faster, and so may be the economic recovery, but it is also
âŚsuggesting that a
loose policy stance well be in place well into 2010
The IMF said in its
October report that: âThe policy stance in the advanced economies should
continue to support demand until the recovery gains a much stronger foothold.
Against this background there is ample room to maintain very low interest rates
and maintain unconventional instruments to counter adverse feedback loops
between the real and financial sectorsâŚâŚDiscretionary fiscal stimulus should
not be withdrawn too earlyâ. We think that the response to this IMF statement
can only be, ditto. The recent good news has been a function of an inventory
swing, better financial market conditions and the effects of fiscal stability
programmes. Recent evidence suggests that it would be too soon to start
withdrawing these measures now. This means that interest rates will remain low
well into 2010, and that quantitative easing and other central bank support to
financial markets will also be required.
Weak US data raise concerns
the recovery is faltering
After last weekâs spate
of weaker US data - culminating in
Fridayâs 263k fall in September payrolls - this weekâs economic releases will
be scrutinised closely for additional signs that the recovery in the global
economy may be starting to falter, see the main article in this Weekly. Falling
equity markets and declining bond yields clearly suggest markets are starting
to doubt the depth and breadth of the global economic expansion. This weekâs calendar
is relatively light of key data. Nevertheless, the services sector PMIs and
external trade figures that are due in many countries will be watched for what
they imply about growth prospects and economic rebalancing. Away from the data
reports, attention will be on government supply in the US, and on the latest
monetary policy meetings in the UK and Eurozone.
ô With the size of the APF almost certain to be left unchanged at
ÂŁ175bn, and the minutes not published for another fortnight, this weekâs UK MPC
meeting is unlikely to cause much of a stir. Instead, market attention will be
focused on the UK services sector PMI,
industrial production and external trade reports. Last week, the September
manufacturing PMI fell a little further below the 50 level that separates
expansion from contraction. But at 54.1, the services PMI is already some way
above 50. We expect this weekâs services PMI to have risen further, led by
continued improvements in business and financial services, underpinned by
public liquidity. Other data in the UK this week are expected
to be mixed. Given the recent weakness of the manufacturing PMI, the August
industrial production outturn is forecast to be broadly flat. The UKâs visible trade
deficit, however, is expected to have posted a further improvement, consistent
with a gradual rebalancing. But as this weekâs figures are likely to show, the
rebalancing is occurring, for now, through falling imports rather than an
improvement in exports. Also this week, Septemberâs producer price and Halifax house price reports
are due, along with the release of the NIESRâs GDP estimate for Q3. We expect
Q3 GDP to rise by 0.3% on the quarter when the official figures are released
later this month.
ô In the US, the focus this week looks set to turn towards bond
markets and government supply, with the Treasury due to auction $39bn of 3-yr
notes, $20bn of 10-yr notes and $12bn of 30-yr bonds. The 10-yr and 30-yr
auctions will be reopenings of existing issues. With equity markets on the back
foot, and the US dollar the recipient of a flight to quality bid, the US government appears to
have little problem at the moment financing its rising budget deficit.
Nonetheless, it will be interesting to see how this week's auctions are
received and the size of any concession required to attract investors. There
are only two key data releases this week: the September non-manufacturing ISM
and the August external trade figures. We expect the non-manufacturing ISM to
have posted a modest improvement, but to have remained below the 50 level.
Meanwhile, the August trade deficit is forecast to be broadly unchanged at
ÂŁ32.5bn. Also this week, various Fed officials are due to speak, including, on
Friday, Chairman Bernanke on the subject of the Fed's balance sheet.
ô As in the UK, no change in policy
is expected from this weekâs ECB policy meeting either. Nevertheless, the
accompanying press conference will be watched closely to see whether ECB
President Trichet adopts any subtle change in tone. Although President Trichet
has hinted at, and will no doubt be asked his views on, a possible exit
strategy, he is unlikely to deviate from the ECB's well-established view that,
while the recovery is at a nascent stage, monetary accommodation remains
desirable. Nonetheless, given the market's limited take-up of last week's
long-term repo, it will be interesting to see whether he shifts his stance on
what constitutes ample market liquidity. The ECB meeting takes place amid a
raft of economic data, including Eurozone retail sales, German factory orders,
and industrial production data in Germany, France and Italy. If the recovery in
the global economy is starting to soften, Germany, as the worldâs
largest exporter, or more specifically its industrial base, could be amongst
the first to reflect the change.
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