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The eye of the storm: a moment of calm before the wind and the rain returns in full force. Is that where the US economy is now? There is a strong case for supposing so: |
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- Housing is still in dire straights with falling prices, excess inventory and a bottom to the market two or three years away
- The announcements of 1st quarter losses by banks on both sides of the Atlantic have been so commonplace that they are now almost ignored
- Sub-prime losses may have been revealed by banks, but what about pension funds and insurers where transparency is practised less? What of Alt A (mortgages of quality between sub-prime and prime)? As housing prices fall mortgage delinquencies are climbing into better quality mortgages, but Alt A losses have scarcely been reckoned
- US GDP managed a tiny increase in Q1, but that was due to inventory increases. That will lead to production cuts in Q2
- Consumer spending is still growing, but at a slowing pace (0.7 % at annual rate in Q1)
- The clouds around credit card financing are gathering
- If cuts in the Fed rate are coming to an end, it is because of the fear of inflation and of negative real rates rather than “mission accomplished”
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Yet some real good has been achieved by the action of the central banks. They have helped the fixed-interest markets to function again, i.e. they have eased the liquidity crisis. That is not the same as saying that they have solved the credit crisis. Mortgage lending, securitisation, leveraged loans and basically all activities of banks will be curtailed for the medium-term future (two to three years is our estimate). Banks need to raise more funds and are doing so both through new equity (how happy they must be that sovereign wealth funds are there to rescue them) and also through bond and preference share issues with spreads of many percentage points over government bonds. None of this bodes well for borrowers, notably for households, who will cut back their spending further and for private equity, and other forms of leveraged investment. |
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There is nevertheless an enormous amount of money looking for a home; it just happens to be held by the oil producers and Asian export economies. Their spending will soften the US recession and probably help Europe avoid one. In fact, we are beginning to think that the world economy will cope quite well with an American recession. |
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Consider for a moment US economic policy and go back to the underlying problem even behind the housing bubble: excess spending at a household, government and national level. It might be thought, or at least we think, that it would be a good idea to bring back spending and revenues more or less in line with each other, and that a start could be made with government and household spending (match those two and the balance of trade will take care of itself). What does the Federal Government do? It gives back taxes, thereby worsening the federal budget imbalance and encouraging more consumer spending. In fact, its policy is specifically aimed at encouraging spending, and the fear is that households may prefer to pay down their debts with those extra dollars rather than spend them. If they do reduce debts, they will be showing greater responsibility than their government! They will in fact be taking advantage of the government choosing to socialise consumer debt. Whatever consumers do, nothing, precisely nothing, will be achieved towards solving the USA’s chronic economic problem of spending more than it earns. |
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Focus |
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(–) Europe: lower growth forecast for 2008. 1.7% (vs 1.8% initially forecast), and also record inflation at 3.2% in 2008 |
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(?) Spain: home purchases lower by 24.4% in February vs one year ago |
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(!) Germany: the GFK index of consumer confidence increased to 5.9 points in April vs 4.8 points in March |
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(!) Deutsche Bank: reported a net loss of EUR 131 million in Q1 and wrote down EUR 2.7 billion assets |
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(–) Hungary: 2nd rise in benchmark rate in a month, by ¼ % to 8.25 % to combat inflation |
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(–) Iceland: inflation in April reached 11.8%, the highest since September 1990. Could launch an SWF. |
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(–) Russia: the Central Bank has raised its rate by ¼ % to 10.5% |
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(–) India: the Central Bank is combating inflation of over 7% by increasing the proportion of liquidity that commercial banks must hold |
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(?) Commodities: they have almost all come off their peaks this week, but too early to judge whether bubble bursting |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question |
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