They worry how bad a US recession could get, and how badly it would hit the world
(FRANKFURT) Since late last summer, the US economy has demonstrated an enduring power to surprise. And not for the better.
Investors worldwide are pondering the prospects for a recession in the United States, their latest and furthestreaching preoccupation resulting from a succession of bad news that the US economy, the world’s largest, has delivered since the onset of global financial turmoil.
When credit markets seized up, the product of mounting losses linked to the American mortgage market, stocks dived, then recovered, as investors factored higher borrowing costs into the outlook for corporate earnings. The changes, some reasoned, were an imaginable step away from the easy money of recent years.
But as large banks in the US disclosed losses in November, equity markets plunged again to account for a lending system that, it turned out, needed to purge losses and be recapitalised.
Stocks recovered somewhat in December. Now the focus among overseas investors has jumped to recession, and a conviction that the US cannot avoid it has became embedded in many market watchers’ and investors’ psychology.
‘We have moved from a phase where an assessment was made on the credit situation, which is improving, onto the macroeconomic news flow,’ said Jacques Cailloux, chief euro-area economist at the Royal Bank of Scotland in London. ‘And if you look at the US, the data has not been very encouraging.’
On Monday, investors ignored the assurances last week from Federal Reserve chairman Ben Bernanke that the US might avoid recession; instead, they have begun to ask how bad it could become – and how bad that would make it for the rest of the world.
‘Ten days ago, only a very few people thought this would be a bad one,’ said Erik Nielsen, chief European economist at Goldman Sachs in London. ‘But now you have people debating just that.’
The latest panicky discussion – which ushered Asian and European markets on Monday and yesterday to some of their steepest losses since September 2001 – revolves around whether the normally resilient US economy will suffer a sharp, protracted downturn or a brief, shallow slowing if consumers regain their footing after the long period of free spending by borrowing against the value of their homes.
Emergency proposals with broad support from the Republican White House and many congressional Democrats to stimulate the economy, coupled with further signs that the Fed will again cut borrowing costs to cushion the blow, suggest agreement in the US that the economic downturn is a serious threat and must be addressed immediately.
That sense of urgency is also fuelling further debate among policymakers in Europe and Asia about whether their economies are truly as insulated from US woes as many would like to believe.
Investors in Asia, conditioned by the roaring economies of emerging markets like China and India, had resisted factoring the chances of a recession in the US into equity prices, stock strategists said – a stance that helped ward off losses in recent months. But now that expectation of a recession is wider, the adjustment in the markets has been jarring – a point evident in Monday’s stock losses.
The signals from the US have been strong enough that the financial markets are betting that Europe will take a much bigger hit than previously expected.
This conviction is strong enough that investors are behaving, based on signals from the bond market, as if they expect the European Central Bank (ECB) to ease interest rates later this year – even though the bank has given no such signal.
‘Overall, the market is sending a message to the ECB that the outlook is very different from what the bank has said,’ Mr Cailloux said. ‘The markets are pre-empting the ECB.’
Instead, the European bank has threatened to raise interest rates – rather than lower them, as is happening in the US – if labour unions demand compensation for food and energy price increases in new wage settlements, a move that could be expected to increase inflation, which is already 3 per cent in the euro zone.
Yet even the president of the European bank, Jean-Claude Trichet – who maintains that the euro area can continue to grow solidly despite deteriorating conditions in the US – acknowledged recently that the slowing in the US must be watched carefully.
In trying to estimate how much American consumers might curb their spending, slowing the economy further, some analysts are beginning to make comparisons to Japan’s long stagnation of the 1990s.
This view holds that consumers have overdone things to such a degree on cheap credit and loans from ever more expensive homes, that the adjustment could drag out more than a few quarters. At the least, this thinking goes, corporate earnings could be tame even after the economy stops contracting, slowing any recovery.
Source: NYT (Business Times 23 Jan 08)