FYI | Jul 06 2009
By Chris Shaw
ANZ Banking Group chief economist Saul Eslake is of the view the worst of the global financial crisis has now passed as quarter-on-quarter growth is likely to turn positive in the second half of this year, but he remains far from optimistic in the sense he expects any recovery to be slow and fragile.
One positive is he doesn’t expect the stimulatory fiscal policies put in place by governments around the world to provide much of a boost to inflation, so while suitable exit strategies from these policies will be needed they won’t be required anytime soon, in Eslake’s view.
Over the past year Eslake notes the sequence of the downturn was the large scale destruction of household wealth from falling equity and property prices led to a dramatic decline in household spending, which created a spike in inventories that was difficult to work through given the freezing of credit markets. This caused production of “big ticket” items in particular to fall.
Lower production and demand for such goods meant global trade fell heavily and this has had the effect of dragging exporting nations such as Germany and Japan into the downturn after they escaped much of the initial impact, the result being the recession has been felt harder in these countries than those such as the US and UK where the crisis first reared its head.
The good news in Eslake’s view is this cycle appears to have largely run its course, especially in Asia where industrial production levels are recovering, but this is countered by the not so good news of a lack of any sign of a self-sustained strengthening in demand, especially from the household sector.
The implication here is the current expansionary economic policies in place around the world are likely to remain in play for some time yet, a fact Eslake suggests the various governments appear to understand far better than do market participants pricing in expectations of rate hikes or other restrictive measures.
As an example of this Eslake points out in December last year the US 10-year bond yield had dropped to 2.0%, which meant investors were implicitly pricing in some deflation over the next decade. The US Federal Reserve subsequently introduced quanititative easing measures that have since seen bond yields increase by enough to factor in inflation of 2.0%, which is exactly in line with the Fed’s target and so shows their quantitative easing policy is working.
This is especially the case as the current policies aren’t likely to create a situation of sharply rising inflation given the excess capacity in the US economy.
Looking at the Australian outlook, the bank’s economist Riki Polygenis notes the Aussie economy so far has been the only advanced economy to avoid two quarters of negative growth as aggressive and pre-emptive policies have helped insulate various sectors of the economy from the worst of the downturn, while the nation’s exposure to Chinese demand for raw materials in particular has also provided significant support.
Polygenis expects GDP growth will be basically flat in 2009 and limited in 2010 at around 0.5% thanks to lows levels of business investment, before returning to a trend rate of growth of 3.25% in 2011. The key remains the health of the labour market as this provides the main link between the spending and re-leveraging of households and the ongoing consolidation process of many businesses.
The news so far has been solid, Polygenis noting while employment has come to a halt it has not started to weaken appreciably as has been the case in previous downturns. Forward indicators suggest the labour market has further to weaken in coming months and so this remains a concern, but on Polygenis’s numbers any falls are unlikely to be as severe as in the last two recessions.
With respect to New Zealand, the bank takes the view the economy is rebalancing away from its domestic centred model of the past 20 or so years to one where greater importance is placed on exports, savings and earnings. Such a process will take time in the bank’s view and so is likely to last for the next several years, though a short-lived upturn is expected in 2010/11 as the combination of policy stimulus, pent-up demand the pending rugby World Cup impact.
Similarly any recovery in Asia is not expected to be swift, while the bank also points out it also won’t be uniform across the region given different levels of effectiveness of policy stimulus measures and export dependency. In other words, China excepted, a recovery in Asia will need to come from a combination of existing momentum, fiscal stimulus measures and foreign demand, which means stronger buying from US and European consumers in particular.
In timing terms the bank expects a gradual recovery to get under way later this year, building through 2010 and a return to trend rates of growth in 2011. Risk remains to the downside, meaning any recovery to such trend rates could take longer than the bank is presently forecasting.
Such an environment would be positive for the Asia ex-Japan currencies and the bank sees some upside here given such currencies are beneficiaries of investors taking on additional risk, though it advises caution given expectations of continued volatility as the recovery gradually takes hold.
For the Australian dollar specifically, the bank notes relative yields are offering support at present, as are relatively high commodity prices. Given the Aussie currency’s traditional role in terms of leading the global economic cycle given its bias to commodity prices, the bank takes the view at around US80c at present it is not too far from fair value levels.
Longer-term the trend looks supportive as there appears to be something of a structural shift occuring as stronger commodity prices imply an improvement in Australia’s terms of trade and such an outcome would support higher equilibrium prices for the Aussie dollar, especially if once the financial crisis has played out the US currency returns to its declining trend.
Short-term risks include further bouts of risk aversion and a correction from the rally in recent months, one that could be aided by any further cuts to interest rates by the Reserve Bank of Australia. The bank doesn’t see this as preventing further rises in the Aussie dollar though as they forecast a rate potentially as high as US90c by year’s end.
