The world economy is sliding into a “twilight zone,” trapped between outright expansion and renewed recession.
“It could go either way,” said Joachim Fels, chief economist at Morgan Stanley in London, who coined the description in an Aug. 15 report. “It doesn’t take much to tip us into a global recession.”
The quandary is forcing central banks back to the fore, with the Federal Reserve last week embarking upon a third round of quantitative easing and the European Central Bank standing ready to buy bonds. While the moves were enough to propel the Standard & Poor’s 500 Index to its highest since 2007, the test is whether they can lift the global economy from its so-called stall speed.
“Markets make fabulous economists, so a rally is often followed by a pick-up in the economy; but there’s likely to be a consolidation as softer data arrives in the near term,” said Trevor Greetham, who helps manage the equivalent of $225 billion as director of asset allocation at Fidelity Worldwide Investment in London. “There’s a two-way tension.”
That tension is reflected in the calls of equity strategists, who divide between those unnerved enough by the opaque economic outlook to shun stocks and those declaring stimulus and liquidity as reason to buy them. Morgan Stanley predicts a 20 percent decline in the S&P 500 to 1,167 through December. Credit Suisse Group AG forecasts gains will be sustained, and the U.S. benchmark will end the year at 1,500. The index was 1,461.19 (SPX) at 4 p.m. yesterday in New York.
“If central banks believe that QE works, and these benefits outweigh the costs, they will continue to pursue it,” Andrew Garthwaite, a global equity strategist in London at Credit Suisse, said in a Sept. 14 report. “We recommend buying.”
The warning from Morgan Stanley, echoed by Citigroup Inc. and Pacific Investment Management Co., is that even with central bank support, the recent slowdown means growth is around the level at which it could suddenly evaporate into recession. That leaves economies increasingly vulnerable to a slump-inducing shock as Europe’s debt crisis festers, the U.S. nears its fiscal cliff and emerging markets slow.
The deceleration leaves central banks as first responders, even amid questions about the power and scope of monetary policy to provide much more strength after most benchmark interest rates have been cut to record lows and officials have embarked upon asset purchases.
The Fed last week said it will expand its holdings of long- term mortgage securities -- this time without limit -- and probably hold the federal funds rate near zero “at least through mid-2015,” longer than its previous pledge. The ECB this month agreed to buy the bonds of governments that accept austerity conditions in return. Chinese Premier Wen Jiabao said Sept. 11 the world’s second-largest economy has room for monetary and fiscal measures.
Fels predicts the central banks of the euro area, China, U.K. and Japan will be among those easing monetary policy even further. In doing so, they will support asset prices, prevent deflation, help avert sovereign defaults and maintain some economic growth, he said.
What the central banks can’t do is substitute for politicians dealing with budgets and structural challenges, such as delivering a fiscal union in the euro area or tackling the more than $600 billion in U.S. spending cuts and tax increases that will start in January unless Congress acts, Fels said.
“Central banks have steered us from recession, but on their own they can’t bring us into sustainable recovery,” he said. “To get out of the twilight zone takes government action.”
At Credit Suisse, Garthwaite says quantitative easing makes it easier for governments to cut debt by fanning inflation expectations and also boosts growth by keeping bond yields low.
Goldman Sachs Asset Management Chairman Jim O’Neill, who says he remains “one of the minority bulls,” points out U.S. households are taking advantage of record-low interest rates to pare debt and home prices are displaying signs of a bounce. The ECB has committed to keeping the euro alive, and even some troubled nations, such as Spain, have turned more competitive. Meantime, China is transitioning to “higher quality” expansion based on local consumption, he said in an interview. “The likelihood of another global recession remains currently low.”
‘Feed the Market’
Mark Mobius, who helps manage more than $40 billion as executive chairman of Templeton Emerging Markets Group, said the Fed will continue to “feed the market” until employment -- stalled above 8 percent in the U.S. since February 2009 -- rebounds, and the ECB and Bank of Japan will join it in pumping out cash.
Economists at the Jerome Levy Forecasting Center in Mount Kisco, New York, are more bearish. Easier monetary and fiscal policies can deliver only a “contained depression” by helping offset the financial volatility and balance-sheet repair that would otherwise spell a deeper slump, they say.
“There’s going to be fragile growth globally and a potential for instability,” said Srinivas Thiruvadanthai, director of research at the center. The need for investors to stay “defensive” means they should buy U.S. Treasury securities, even with the yield on the 10-year bond at 1.84 percent yesterday, he said.
While few analysts are forecasting a return to worldwide recession -- and certainly no slump akin to the 0.6 percent contraction of 2009 -- the longer the expansion remains lackluster, the more precarious economies become, Saumil Parikh, a managing director at Newport Beach, California-based Pimco, said in a Sept. 12 report.
“The concept of stall speed is a contentious one, but one that we tend to believe does influence economic outcomes,” Parikh said. Sales growth can slow only so far before it “sets in motion an aggregation of cost cutting, labor shedding and inventory reductions that constitute a typical recession.”
With Parikh warning ‘the probability of more widespread recessions has increased,” Pimco, manager of the world’s largest bond fund, last week forecast global growth will slow to between 1.5 percent and 2 percent next year from 2.2 percent in 2012.
In the U.S., payrolls rose less than projected in August, and manufacturing shrank for a third month in the longest decline since the 18-month recession ended in 2009. Euro-area services and manufacturing also contracted for a seventh month in August, and the unemployment rate is a record 11.3 percent.
While emerging markets powered the world through the last recession, many now are sharing the pain. Chinese industrial output rose at the slowest pace in three years last month, underscoring the risk that full-year economic expansion will be the lowest in more than two decades.
JPMorgan Chase & Co.’s international all-industry purchasing-managers’ index is close to June’s three-year low of 50.1, implying expansion of about 1.5 percent worldwide, and its new gauge based on incoming data suggests 2 percent. Korean exports -- a barometer of demand because they reflect the health of key trading partners such as China -- fell 6.2 percent in August from a year earlier.
Corporate bellwethers also express discomfort. FedEx Corp., the world’s largest cargo airline, today reduced its profit outlook for the year through May after quarterly earnings dropped for the first time in almost three years amid lower demand for premium shipping services.
“Weakness in the global economy constrained revenue growth at FedEx Express during our first quarter and affected our earnings,” Memphis, Tennessee-based Chief Executive Officer Fred Smith said in a statement.
New research published this month by Nathan Sheets, global head of international economics at Citigroup in New York, shows just how fast recessions can materialize. When U.S. growth slid below 1.5 percent in the past, expansion typically dropped 3 percentage points in subsequent quarters, and growth elsewhere mapped up to 30 percent of the U.S. decline, he found.
What matters now is whether the risks turn into reality. Morgan Stanley’s Fels -- who last week cut his forecast for growth for a third straight month to 3.1 percent this year from March’s 3.7 percent estimate and to 3.3 percent in 2013 from 4 percent -- identifies two key threats.
One is rife policy upheaval. No matter who wins the U.S. presidential election in November -- Democratic President Barack Obama or Republican challenger Mitt Romney -- the fiscal cliff is looming. Japan may hold early elections, and China’s leadership is changing.
Even with the ECB’s offer to buy short-term bonds if governments adopt austerity programs, the 17-nation euro area still lacks fiscal ties, while budget cuts are compounding recessions and fanning suggestions the group still could splinter. Neither Spain nor Italy has sought the ECB’s aid yet, and Greece is struggling to earn its latest tranche of cash.
Emerging markets also are finding it tough to transform their economies, Fels says. China is seeking to shift from a reliance on exports to emphasis on domestic drivers, while India’s ability to support consumption through government spending is threatened by fiscal deficits. Commodity-dependent Russia and Brazil may suffer from less foreign demand.
The research by Sheets, director of the Fed’s international finance division until last year, suggests the worldwide stall speed is about 3.5 percent, above the 3.2 percent median forecast for 2012 of economists surveyed by Bloomberg News from Sept. 7 to Sept. 12.
At 2 percent, growth traditionally has fallen “significantly further,” as in the recent financial crisis, or stagnated for several years, as in the early 1990s, he said. “The global economy is very vulnerable at the moment.”
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