New world recession likely less severe than in 2008-09

KUALA LUMPUR: Standard Chartered Global Research remains optimistic that US growth will pick up in the coming months, despite weak consumer confidence, as the shocks from the first half of 2011 (1H) fade while it expected a global recession to be less severe than in 2008-2009.

In its outlook report, it said the debt crisis in Europe will at best remain a lingering problem, dampening investor and business confidence; at worst, it will blow up into a major banking crisis, resulting in a new world recession.

“Our central view is that a European blow-up will remain only a threat, holding back world growth rather than bringing a new recession. But the risks are rising as Greece struggles to meet its targets and Italy moves glacially towards adjustment,” it said on Friday, Sept 16.

StanChart Resarch said a new world recession would likely be less severe than in 2008-09, but it would bring further losses for investors and banks, adding this would also boost unemployment and threaten social cohesion. Of concern was that it could bring damaging new economic policies such as increased protectionism, crimping the subsequent recovery.

As for emerging markets, it expected them to likely suffer a recession or slowdown too, though most have strong fundamentals and room for monetary stimulus and – in some cases, including China – fiscal stimulus.

Arguing its case why a recession would be avoided , it said recent data on trade and inventories suggests that the US 1H GDP growth woudl be revised up slightly, though it will still be little more than 1% (seasonally adjusted annualised rate, or SAAR).

However, it was more optimistic in 2H as it expected a significant improvement in H2 as car assembly picks up and households are able to spend rising incomes on extra items rather than having to spend more on gasoline.

“Historically, while sharp dips in confidence caused by political or market events have often kept consumer spending weak, they have not usually triggered a spending slump. Similarly, the ISM manufacturing index often falls to around the 50 level in the early years of an economic recovery, and this does not necessarily point to recession,” it said.

StanChart Research however pointed out there was no quick fix to the European crisis. It cited that Germany would not take on full liability for problem countries’ debts and will insist on private-sector involvement.

The eventual haircut on Greece could be 70% or more, but Greece on its own is small and is not a major threat to Europe’s banks.

European interbank markets and long-term bank funding are seizing up because of worries that Spain and especially Italy could go the same way.

“We think Spain and Italy will respond to market pressure and take action to improve their fiscal outlooks. Meanwhile, European banks can fund themselves through European Central Bank (ECB) programmes and by issuing covered bonds, making an immediate credit crunch unlikely,” it said.

StanChart Research also said there was no question that a new recession now would be bad news for the world economy and for investors.

“While investors are currently cautious and pessimistic, stock markets are not yet pricing in an outright recession, which would mean a slump in profits and would significantly increase uncertainty about the long-term economic and political outlook. Also, the West has no room for a major new fiscal stimulus,” it said.

However, in its view, a new US recession would not be as severe as in 2008-09. First, central banks and governments stand behind the banks and will not allow a domino effect of bank failures, as was feared in 2008 after the Lehman bankruptcy, or a sharp cutback in bank credit. Second, the impact on business spending will be less severe, partly because confidence is already lower and so most businesses are already operating very cautious balance sheets.

StanChart Research said equipment investment and inventories have risen back to near 2007 peaks and would doubtless be cut again, but both commercial and residential CONSTRUCTION [] are already at rock bottom.

“One uncertainty is how US consumers would behave,” it said. In 2008-09, Americans sharply pushed up the savings rate and drastically cut back on big-ticket items, especially cars.

The savings rate could go higher still, but the likelihood is that it would increase by less this time, while car sales, are running at only 75% of 2007 levels. House prices would fall further, hurting consumers and banks, but this decline could eventually spur new purchases as buyers stepped in.

StanChart Research said finally, a recession now would quickly be met with renewed quantitative easing – “QE3” in the US, but also new programmes in the UK and probably also Japan and the euro area. This would limit the downside for stocks and thereby limit the hit to confidence.

“While a new fiscal stimulus in the West is unlikely, the automatic stabilisers would be allowed to work. Also, world oil prices would likely fall again, helping importing countries while probably having little effect on exporting countries’ spending, thus providing a significant new stimulus.

“Overall, then, we think emerging markets would face a less drastic slump in orders and in commodity prices than in 2008-09. Most would respond with interest rate cuts and, in some cases, new fiscal stimulus, mitigating the downturn,” it said.