Recovery signals across the globe have prompted upgrades in growth forecasts. Consensus Economics Inc's October 2008 issue shows long-term projections for growth in the G7 and Western Europe turning positive albeit weak in 2010. GDP forecasts for Germany, France, the UK, Italy, the Eurozone, Netherlands, Spain and Switzerland will remain below 1.5%. By contrast, the US, Canada and Norway are expected to grow more strongly. Aging populations, rising debt burdens and sizeable pensions overhang will continue to deflate price pressures and subtract from long-term growth. Hence, significant challenges remain for the global economy, particularly in the developed world where the consensus is for long-term growth to decelerate from productivity-fuelled bursts at the beginning of the decade. This sober thought has not eluded policy makers, with governments and central banks alike agreeing at the G20 summit to tread carefully in withdrawing stimulus or risk another dip in the global economy.
Where can surprises come from?
While consensus is hardly always right, the wide dispersion of economic forecasts in 2009 with the alphabet soup of U, V, W or L shaped recoveries have tapered to a narrower spread of modest recoveries in 2010. Forward-looking manufacturing indices from ISM, PMIs and CBI industrial trends indicate an expansion in industrial output. Restocking trends across the globe and temporary fiscal supports to manufacturing and, in particular, the auto sector has lifted growth above most forecasts in the third quarter. However, concern is returning that momentum could weaken going into the fourth quarter. Next year’s industrial production consensus in the US, for example, has seen a mild uptick to 3.5%, but elsewhere, the GDP outlook has been complicated by massive job cuts. Some economists estimate that payrolls will need to see three or more years of solid growth before fully covering the massive losses of the past year.
Will the US consumer surprise?
If US unemployment heads towards 11%, another stimulus package focusing on jobs cannot be dismissed. Currently, the consensus forecast is for personal consumption to recover at a rate of 1.5% in 2010 with business investment continuing to contract at -0.3%. This is optimistic when compared to what the IMF and OECD have forecast at 0.9% and 0.5% for personal consumption growth.
Why would the US consumer surprise?
While it would be hard to imagine consumption surprising on the upside with the unemployment rate hitting double-digits and the heavy indebtedness of the average American, you could say the exact same thing of the economic rebound in 2009 where few economists expected the strong economic rebound nor the massive rally in financial assets we are now experiencing. What is the lesson to be learnt then? That investor and consumption behaviour alike tends to repeat itself ! The record level of low interest rates pushed investors back to searching for yield, propelling a massive rally in risk assets. Likewise, even with the credit crunch episode only a short while ago, memories are short, and the US consumer may be ready to take on debt again once employment stabilises. Note too that the US savings rate has hit a barrier at 6% and is starting to decline again.
What about inflation?
The inflation-deflation debate is unlikely to get any respite in 2010. There are several tipping points in this debate including the return of bank lending, the return of leverage and the return of wealth effects, themes that dominated the asset bubble in the mid-2000s before the bubble burst. Let’s look at each in turn.
Will banks restart lending?
Arguments that the financial intermediary process is broken and the credit multiplier bust are commonplace. With new regulations to increase tier 1 capital and the drawdown of loan commitments over the next few years, banks are rightfully cautious about making new loans. When will banks lend again? One factor that could support a stronger level of lending than currently expected is a flatter yield curve that compresses bank margins. As bank margins compress, banks are forced to take on more risk on their balance sheet to enhance returns. The other force that could prompt businesses to borrow is higher interest rates. While lenders remain conservative, corporates have bypassed traditional bank channels and are turning to capital markets to raise funds. But if economic growth rises faster than is currently expected and is accompanied by rising inflation expectations, companies could return to traditional sources of borrowing, locking in the low level of interest rates while they can.
Return of leverage
The massive deleveraging that occurred post-crisis has some economists sounding the death knell on leveraged plays reappearing in the next one to two years. Once again however, we remind you of how short memories are, and that a prolonged period of low interest rates can indeed propel even the most risk averse to search for yield. Thus, one cannot dismiss leveraged plays from making a comeback in 2010, especially as confidence that a double-dip is not in the forecast horizon rises and monies pour back into the hands of hedge fund managers, as we are now seeing.
Wealth effect, yes or no?
A final consideration in our beyond consensus and hypothetical look into 2010 is that wealth effects can return to boost spending and growth. Just like the mortgage equity withdrawal during the housing boom supported an extended rally in asset prices and growth, similar wealth effects from the current asset boom cannot be discounted. While the wealth effects can be seen to be strongest in commodity-based currencies due to their positive terms of trade shock from surging commodity prices, even deficit countries like the US and UK could see wealth effects return if consumers feel things are getting better and decide to spend instead of save. Political will to allow the consumer to fail and unemployment to soar, basically, allowing imbalances to unwind, remains weak. Popularly elected governments and hopeful opposition candidates continue to lobby aggressively for enlarging social security nets to provide a safe landing for the leveraged consumer.
Rebalancing - is it for real?
The crux thus comes down to this: Is the globe really ready to change its growth model with the US consumer spending less and the Asian consumer saving less? The conclusion remains far from clear. While the impetus to rebalance the world to reduce the risk of another crisis has been strong in 2009, what’s there to say that the momentum would not fade away if policy makers lose sight of the bigger picture and focus on near-term political agendas? This is arguably the constant challenge to the global financial markets – that of getting policy right.
Disclaimer: This material is for general information only. No representation or warranty is made that the information contained in this material is accurate or complete and it should not be relied upon as such or used in place of professional advice. The BNP Paribas Group does not accept responsibility for any loss arising from any use of this material or any action taken by anyone using this material. © BNP Paribas (2009). All rights reserved. BNP Paribas is incorporated in France with limited liability. Registered office 16 Boulevard des Italiens, 75009 Paris.
Chin Loo Thio is a senior FX and interest rate strategist at BNP Paribas