OCTOBER WILL SET OUTLOOK FOR RECOVERY
JANE FOLEY
RESEARCH DIRECTOR, FOREX.COM
ONE year on from the eye of the financial storm, the sense of crisis has abated. The majority of economic data since the second quarter has been far better than most economists would have thought possible in the spring. That said, many warning signs remain and the world cannot shrug off the risk of another dip in output once fiscal incentives start to run dry.
Brent oil futures prices fell by over 8 per cent last week, with a significant part of the move following news of a sharp and unexpected rise in US oil inventories which hit prices hard mid-week. Inventories have been above their seasonal average for some time and their continued failure to correct suggests a misalignment between supply and demand that may pressure prices further into year-end.
A similar story is being told by the soft tone of the Baltic Dry Index, which reflects the degree of capacity in shipping. Having bottomed at the end of last year, the index started to recover along with oil and stock markets in the spring. However, having peaked for the year in June, the value of the index has since halved to a level which represents just 20 per cent of its value in June 2008. Poor demand for shipping points to lacklustre global economic activity which in turn echoes the warnings still evident in the rhetoric of most of the G10 central banks that risks to growth still remain.
SHORT SHRIFT
In October, equity markets will provide fresh direction. A dip in the S&P 500 in early July was driven by fears that the spring rally in the stock markets may have become over-extended. This talk was given short shrift as the majority of US second quarter corporate earnings came in better than expected – an event which had a significant impact on driving risk appetite higher through the summer.
But there was one significant caveat associated with the earnings results – that cost cutting played a significant part, which is consistent with the rise in unemployment and spare capacity in the US economy. The pace of the rise in joblessness has since slowed, suggesting that the positive impact on balance sheets from cost cutting may also have slowed in the third quarter.
Consumers’ spending power is still pressured by rising joblessness and by reductions in the level of their debt which will bear down on demand. This is consistent with the signals stemming from the rise in US oil inventories and the fall in the Baltic Dry index, both of which point to weak demand. The big question for corporates in the third quarter is whether they have been able to maintain their decent performance in this environment. A strong earnings season would likely drive risk appetite higher into year end whereas poor earnings would enhance fears that the rally in risk has overstated the recovery in demand.
LOOSE STANCE
Consumers may remain under pressure but monetary and fiscal incentives will continue to have a considerable impact on economic activity as we approach the end of 2009. In most major, developed countries, it is likely that monetary policy will retain its present loose stance through to the middle of next year (Norway and Australia are two probable exceptions to this).
While it is difficult to gauge, there is still plenty of impact from fiscal incentives moving through the system. However, the potential for fresh fiscal incentives is running dry as government budget deficits rise. In the UK, the temporary reduction in Vat will be reversed on 1 January 2010 and the car scrappage scheme is expected to have run its course by March 2010.
Whether or not demand will have recovered sufficiently next year to keep the global economic recovery on track without fresh fiscal stimulus remains to be seen, but it is at this point that the danger of a W-shaped recession will be most pronounced. This year, strong growth in China and elsewhere in Asia has been a crucial prop, but there is also speculation about how much longer China will retain its supportive fiscal position.
Despite the rise in risk appetite through the summer months there are still sufficient risks to global demand to suggest that the path back to trend rates of growth will not be plain sailing. Risk appetite was pulled back in the latter part of last week but there is nonetheless potential for this to extend.
In this environment it is possible that euro-dollar will hold lower levels rather than steaming ahead to 1.500 and that equities and oil prices could consolidate at lower levels.
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