FYI | Apr 03 2008
By Chris Shaw
Rather than global decoupling, where the rest of the world shakes off the current weakness in the US economy and continues to grow at a reasonable pace, Morgan Stanley Chief US economist Richard Berner favours a recoupling scenario that would see the European and Japanese economies come under renewed pressure.
Berner suggests this scenario is actually now playing out, though so far the effect has been a slow one with different and uneven impacts in different markets and emerging markets in fact showing little sign of any material effect from the slowing in US growth.
For Japan the evidence of a re-coupling to the fortunes of the US economy comes via data showing the US slowdown has impacted on the domestic economy, which remains very weak even as exports have continued to growth strongly. Europe in contrast has avoided the domestic weakness affecting Japan but has endured its own credit crunch and this is likely to put some pressure on the domestic side of the economy in coming months, Berner predicts.
The unevenness he mentions can be seen from his view there is significantly more bad news already priced into the Japanese market than is the case in Europe, though he cautions both markets are likely to see risky asset prices come down if growth slows.
This may play out into a greater downside risk from here in European equities than in Japan as earnings in the former are more vulnerable to falling short of market expectations given the broker has revised down growth forecasts to 1.5% from 1.6% this year and to 1.5% from 2.2% next year. Japan is unlikely to be immune though, Berner seeing scope for it to enter a “mini recession” in the current half given the weakness being shown by the domestic portion of the economy.
The emerging markets in contrast continue to enjoy strong growth on the back of solid fundamentals and factors such as structural reforms, current account surpluses and favourable movements in terms of trade, which is lifting income and wealth levels and attracting increased direct foreign investment.
But even among the emerging nations there are some signs of weakness, with India in particular likely to feel the pinch from a slowing in exports and capital inflows at the same time as inflation is high and monetary policy is tight. Even nations with significant natural resources are dealing with rising costs, so Berner expects regions such as Latin America to also experience a slowing in growth rates.
Taking a possible worst case scenario approach the broker has assessed what would happen if US growth remained weak, energy prices stayed high and the US dollar fell further against other major currencies, its conclusion being global growth would fall to below trend levels both this year and in 2009 while inflation would jump this year but drift lower next year.
Such an outcome would, in Berner’s view, also postpone any recovery in the global economy until 2010 and this would put downward pressure on base metal prices. If this were to occur the “mini recession” in Japan would likely become somewhat deeper, while resource exporters such as Canada and Australia may suffer weaker conditions from a declining wealth effect as a result of a weakening in their terms of trade.
Europe would likely fare a bit better as a weaker economy would reduce inflationary pressures, allowing the European Central Bank (ECB) to become more aggressive in lowering interest rates. China is seen as almost enjoying the US slowdown as it removes some of the growth pressures authorities have been trying to bring under control but Berner sees India as heavily exposed if such a scenario plays out.
