The global banking system is still struggling with major problems related to losses on "toxic assets", primarily connected with housing and property loans. The losses have cut the capital bases of the banks, and this has led to a credit squeeze on the global economy. This is preventing the monetary policy mechanism from functioning normally, which in turn means the recession looks set to be unusually long and deep. So far, the banks have reported writedowns and losses of a little more then USD 1000bn, but there can still be much more to come, according to the IMF. In World Economic Outlook Update, which was published in the past week, the IMF revised up its estimate for total losses in the banking system to USD 2200bn from its earlier estimate of USD 1400bn. In other words, only half of the forecast losses have surfaced so far.
Being able to emerge from the crisis requires that one finds a watertight and sustainable solution to the problems in the bank sector. There are a number of options being discussed at the moment. One is to pump more capital into the banks as compensation for the losses that will inevitably occur. This was what happened in the US in the autumn with the first half of the USD 700bn from the so-called TARP fund. A second option being increasingly worked on is to free the banks of their "toxic assets" and place them in a so-called bad bank, so the banking system can move on and ensure that lending functions as it should, thus easing the credit squeeze. This is the solution Sweden employed during its bank crisis in the early 1990s. A final option is that the government issues insurance on the toxic assets, with all losses beyond a certain limit (the bank's risk) being borne by the government. This would mean the maximum loss for the bank being known, and thus it would be easier to persuade private investors to place capital in the banks. The people involved are currently working flat out to find the best model, and concrete initiatives will probably emerge soon - perhaps as early as the coming week.
Euroland
The past week saw a rather mixed bunch of signals from the eurozone economies. On the one hand, the Ifo indicator of German business confidence surprised on the upside, rising to 79.4 from 76.9. We had expected an increase to 78 - slightly above the consensus expectation of 77.9. On the other hand, the ECB lending data showed a significant weakening of non-financial companies, and the EU Commission's confidence indicators came out at record lows for both businesses and consumers. To top it all, the climate indicator pointed towards the deepest downturn in the economy since this indicator was introduced in January 1985.
Meanwhile, Friday's inflation numbers showed that eurozone inflation is falling fast, with inflation in the flash statistics down sharply from 1.6% y/y in December 2008 to 1.1% in January 2009. Detailed data have not yet been released, but we believe that the fall in inflation was mainly driven by low oil and food prices.
All things considered, this supports our view that the ECB will need to lower its benchmark rates further, and we think that a 50bp cut would be appropriate. However, the ECB has clearly signalled that it has no intention of easing monetary policy at its February 5 meeting, so we expect rates to be cut in March.
In the coming week, the final PMI data for Euroland are due to be released. We expect the numbers to confirm the preliminary figures (manufacturing PMI of 34.5; services PMI of 42.5). Retail sales in the euro zone are expected to decline by 0.2% m/m in December - in line with the consensus expectation. This reflects the generally declining trend of consumer confidence in the wake of rising unemployment numbers. Late in the coming week, industrial production and new order data for Germany will be released. We expect new orders to decline once again, by 2.0% m/m in December 2008. This would be a far more moderate fall than in the previous two months, both of which showed industrial output retreating by about 6% m/m. If we are proven right, new orders in December were down 24.5% on the same month of last year. We expect industrial production to track the downtrend in orders, with production likely to decline by 2.0% m/m, or 9.1% y/y.
Key events of the week ahead
- Final PMI data for Euroland expected to confirm the preliminary data (Monday: manufacturing PMI 34.5; Wednesday: services PMI 42.5).
- Wednesday: Look for a decline in eurozone retail sales of 0.2% m/m.
- Thursday: German new orders.
- Friday: Industrial production data for Germany.
Switzerland: Swiss economy in recession
The Swiss economy is clearly in recession, and its central bank is rattling its sabre. Such is the conclusion from the past week. The important KOF indicator fell even further than we predicted, and we were below consensus. The drop from -0.39 to -0.87 left the KOF at its lowest since the series began in 1991, and removed the last remnants of doubt about Switzerland being in recession. Comments from the Swiss National Bank (SNB) confirmed that, if necessary, it is prepared to turn to unconventional methods. Its scope to reduce the benchmark rate is close to being exhausted, as the bank has already slashed its target for the three-month LIBOR by 225bp since October 2008 to 0.5%. SNB chairman Jean-Pierre Roth said during the week: "We watch the situation carefully and we know there are unconventional means. If necessary we will act." This echoed previous comments from vice-chairman Philipp Hildebrand and fellow governing board member Thomas Jordan that the SNB can still ease monetary policy even though it has already lowered repo rates practically to zero, for example by buying up government and corporate bonds, easing the terms of repo transactions or intervening in the currency market. Given the deeply negative growth outlook for the Swiss economy, the beginnings of deflation fears and the relatively strong comments from the SNB, it is highly likely that the SNB will ease monetary policy further, and this will naturally include alternative channels.
During the week the SNB established a temporary EUR/CHF swap arrangement with the Hungarian central bank similar to the one already in place with the ECB and the Polish central bank. The arrangement, which is an attempt to ease the shortage of CHF liquidity, needs to be seen in the light of the major role that the CHF has played in the loan market not only in Hungary but also in Poland and Austria. Consensus estimates in the market are that more than half of all foreign-currency loans in these countries are denominated in CHF. The bulk of these loans probably have a relatively long maturity (many are mortgages), but given that currency hedging has been used only to a limited extent, the recent appreciation of the CHF against the PLN and HUF in particular is worrying. This potential source of CHF strengthening has been discounted in our forecast, where we still expect the CHF/DKK to trade around 5.03 in three months, even though the possibility of the SNB intervening in the currency market will presumably put a ceiling over the CHF/DKK's upside potential.
Key events of the week ahead
- Friday: Seasonally adjusted unemployment is expected to increase from 2.8% in December to 2.9% in January.
USA: Bank of England to buy corporate credit
On Thursday, the Chancellor of the Exchequer, Alistair Darling, authorised the Bank of England to create a new fund called the Asset Purchase Facility which will buy high-quality corporate credit assets. The facility will be GBP50bn and eligible assets are paper issued under the Credit Guarantee Scheme (CGS), corporate bonds, commercial paper, syndicated loans and asset-backed securities created in viable securitisation structures. The facility will be financed by the issue of Treasury bills and the DMO's cash management operations. Hence it will not be financed by printing money - as with the asset purchase program in the US where the Fed is buying mortgage-backed securities by printing money. However, if the Bank of England deems it necessary to buy assets with central bank money in order to meet the inflation target, it may request this but it has to be approved by the Chancellor of the Exchequer.
The objective of the new facility is to increase the availability of corporate credit, as credit markets have been under severe stress and liquidity is extremely poor. The credit squeeze is blocking investments and making it difficult to refinance maturing loans. This adds tremendous uncertainty to the corporate sector. Next week we expect the Bank of England to follow up with an additional rate cut of 50bp taking the Bank Rate to 1.0%.
On the data front, the past week offered more house price data, which showed a further decline in house prices. Nationwide house prices fell 1.3% m/m. House prices are now down 20% from the peak and are getting closer to fair levels compared with income (see chart). Financing costs have come down materially lately, as, for example, 12-month Libor rates have fallen from 6.5% to 2.5% in less than four months. Credit tightening continues to be a major headwind for the housing market and there is a clear risk of an undershooting in house prices. Hence, we expect house prices to continue to fall over the next year, but the pace of decline is expected to taper off. On the consumer side, the distributive trades report offered no relief as the expectations index fell further to -52 for February from -49 for January - an all-time low for the index.
Key events of the week ahead
- Key event will be the Bank of England meeting on Thursday when we expect a further rate cut of 50bp.
- On Monday PMI manufacturing is expected to rise a bit further in line with what we have seen in other business surveys in Europe.
- PMI service and industrial production is also on the agenda for the coming week.
USA: Fed on hold, key data ahead
There were no surprises at the FOMC meeting during the week. The Fed left its benchmark rate at the interval 0- 0.25% and communicated clearly that interest rates will remain at these unusually low levels for some time. Given the recent rise in long yields, there was some speculation ahead of the meeting that the Fed would step up its quantitative easing by upping its purchases of mortgage-backed securities or even start buying up Treasuries. This did not happen, but the Fed sent a clear signal that it is prepared to do both if the situation deteriorates. We still expect the Fed to leave its benchmark rate unchanged at close to zero for a long time. In the coming months the risk will still be on the side of further quantitative easing (see Flash Comment - FOMC: Ready to scale up purchases).
The two most important sets of figures for the US economy in the coming week are the ISM survey and the employment report for January. We expect the ISM manufacturing index to surprise slightly on the upside, rising from 32.9 (revised) to 33.5. As we argue in our report Research US: Manufacturing recovery ahead, that we expect the manu facturing sector to begin to stabilize in the coming months. This means that we see the ISM index hitting 42-44 by mid-year. This would be in keeping with stabilization of the economy - in other words, zero growth in Q2. The labour market is still under pressure, and we do not expect unemployment to stabilize until the beginning of next year. That said, there are signs that slightly fewer jobs went in January than in the preceding months. We expect non-farm pay rolls to fall by 450,000 and unemployment to climb to 7.4%.
The House of Representatives passed Barack Obama's USD 800bn-plus stimulus package during the week. In the coming week the focus will be on whether Senate can do the same. We expect the final decision to come before 13 February when Congress breaks for its winter recess. Some of the tax cuts may feed through during Q2, but most of the package will not impact until H2 (see Research US: How much bang for the Obama buck?).
Key events of the week ahead
- Monday: We expect the ISM manufacturing index to edge up from 32.9 in Dec. to 33.5 in Jan. (consensus 32.8).
- Wednesday: We expect the ISM services index to fall from 40.1 in Dec. to 39.5 in Jan. (consensus 39.0).
- Friday: We expect the employment report to show a drop in non-farm payrolls of 450,000 in January (consensus 500,000).
- Speeches from FOMC members throughout the week.
- Keep an eye on the passage of the stimulus package through Senate and a potential new financial rescue package.
Asia: Lowering our growth forecast for Japan again
Once again we have significantly lowered our growth forecast for Japan. This is, not least, because we now believe that GDP plummeted by a whopping 2.1% q/q in Q4 last year. The December trade data were miserable, and we believe that net exports alone cut GDP growth by around 2 percentage points in Q4. Also, consumer spending seems to have been hit by the financial crisis and labour market weakness as early as Q4, so consumer spending probably contracted by 0.6% q/q in the final quarter of last year. Without the substantial inventory building that is likely to have taken place in Q4, GDP growth in the quarter would probably have been even weaker. Meanwhile, the need to reduce inventories in manufacturing industry will be a drag on growth in the coming quarters. On top of this, the government's stimulus package looks likely to be (at best) delayed, so consumer spending will probably not begin to pick up until some time in Q2 this year. That is why we have lowered our estimate of GDP growth for Q1 09 to -0.8% q/q. All in all, this means we have cut our growth estimate for 2009 to -2.6% from -1.5%.
The weak growth outlook will bring additional pressure to bear on the Bank of Japan (BoJ) to find new ways of stimulating economic growth now that the central bank, in reality, cannot lower its rates any further. The growing focus of the BoJ on easing companies' access to funding is a step in the right direction, though we wish to emphasise that Japan's current weakness is due to a huge external demand shock that has created substantial overcapacity rather than to the financial crisis having depleted the funding sources available to Japanese companies. As such, fiscal easing is currently more important for Japan than new measures to ease access to finance. Political uncertainty and the failure of the government to take more effective fiscal action so far are indeed having a very negative impact on the Japanese economy at the moment.
In China, the past week saw the beginning of the Year of the Ox - a year that is not normally associated with economic prosperity. Given the serious challenges facing the Chinese economy, securing prosperity would indeed require the hard work and perseverance of the ox. That said, the Chinese economy is one of few Asian economies that have not seen universally negative indicators recently. Quickening loan growth and an increase in manufacturing PMI data in December indicate that the Chinese economy is reaching bottom. The focal point in the week ahead will be the release of January PMI data from the CLSA and the NBS. We expect December's positive trends in both indicators to have continued in January.
Key events of the week ahead
- In China, attention will focus on Wednesday's release of manufacturing PMI data from the CLSA and the NBS.
- In Japan, few major releases are due out in the coming week, though December wages and salaries will be published on Wednesday.
- In the rest of the Asian region, we await with interest the release of South Korean trade data for January on Monday and the policy meeting at Bank Indonesia Wednesday, where we expect benchmark rates to be cut by 50bp.
Foreign Exchange: In the hands of governments and central banks
The British pound was the big winner among G10 currencies in the past week, with EUR/GBP managing to retreat from a top of 0.9520 on Monday to break below 0.90 early Friday. The strengthening of the pound comes after the major sell-off the previous week, when the pound weakened by more than what both relative interest rates and equity market developments would have suggested. The Norwegian krone, meanwhile, continued to strengthen, while the US and Canadian dollars also appreciated against the euro. Generally speaking, it was the countries that launched new fiscal measures that strengthened over the week. The week's big loser was the New Zealand dollar, which experienced a major fall following the Reserve Bank of New Zealand's 1.50 percentage point rate cut to a historic low of 3.50%.
That we find ourselves in a particularly deep global recession is no longer news. Unfortunately, however, this does not rule out further negative surprises. This was underscored in the past week when the International Monetary Fund (IMF) yet again cut its expectations for global growth in 2009, with a forecast now of just 0.5% - the lowest level of growth since World War 2! The deep global slowdown naturally gives rise to a need for initiatives from the world's governments and central banks, which have indeed already been extremely active. The past week saw yet another raft of measures, with the Norwegian government presenting a comprehensive fiscal package, the US House of Representatives passing the government's proposed USD 819bn stimulus package, and US President Obama discussing new initiatives (establishment of a "bad bank", see "Editorial" and "Fixed Income") to take illiquid assets off bank balance sheets. Finally, the British Treasury presented a similar plan, which would give the Bank of England the option of buying GBP 50bn worth of assets in the market (see "UK"). Both NOK and GBP strengthened against EUR.
Fiscal and monetary initiatives will very probably also be a dominating theme in FX markets in the week ahead, when focus will be on the US Senate's passage of the fiscal stability package and any further news on the "bad bank". While very accommodative fiscal and monetary policies could weaken the dollar via the effects of an increased money supply and worries about the US's chances of financing already large government budget and current account deficits, we maintain our view that this is more a theme for the medium term. Thus we still expect that the dollar will strengthen in the short term as a result of the positive effects on US growth and the subsequent chance that the US could turn faster than Euroland thanks to a more flexible (and thus a much more accommodative) economic policy.
Central bank measures will also attract attention in the coming week, which sees no less than four G10 rate meetings: Tuesday at Reserve Bank of Australia (RBA), Wednesday at Norges Bank, and finally Thursday at the Bank of England (BoE) and the ECB. While we, like the market, expect the ECB to leave rates unchanged, we expect the BoE to cut buy 50bp, which could put pressure on the pound (not least given the latest discussion in the market on whether the BoE will follow the US Fed and move to quantitative easing). If Norges Bank as expected cuts by 50bp to 2.5%, NOK could also face some temporary pressure, and we see a real chance that EUR/NOK could go above 9.00 before the NOK can strengthen substantially once more. In Australia, we expect that the RBA will cut by 100bp to 3.25%, which could help undermine the AUD, which is already under pressure from the global slowdown and the steep fall in commodity prices over the past six months. We still expect that AUD/USD will reach 0.60 in H1 09. Finally, there will be a string of important activity indicators (PMIs) which, insofar as there is no tentative sign of the slowdown stabilising, could lend further support to the defensive currencies, JPY, CHF and USD.
Danske Bank http://www.danskebank.com/danskeresearch
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