DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking: In-between the lines - Bernhard Eschweiler
(firmenpresse) - DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking /
Key word(s): Miscellaneous
Silvia Quandt&Cie. AG, Merchant&Investment Banking: In-between the
lines - Bernhard Eschweiler
16.08.2011 / 08:50
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- Markets fear public debt crises in Europe and US will trigger recession
- Fiscal tightening is a drag on growth, but conditions are not ripe for
recession
- Look for further monetary policy action to prevent liquidity crisis
The equity selloff lost some momentum, but volatility and uncertainty
remain extremely high. Indeed, the risk is that markets will throw up some
more before they come to rest. The avalanche of the Euro debt crisis has
not yet reached the valley and markets fear that the fiscal troubles in the
US and Europe will lead to recession.
To be sure, the current market development will have financial and
sentiment implications that can even lead to recession. However, the job
of economists in times like this is not to chase markets, but to separate
the signals from the noise. Like apples on a tree in the summer, economic
conditions are not yet ripe for a drop into recession. Fiscal tightening
in most OECD economies is a drag on growth, just as it has already been for
more than a year, but not enough to cause recession. However, markets can
shake the tree so hard that some apples will fall off. Policymakers need
to prevent that. Latest moves by the Fed and the ECB are important steps
and more is likely to follow.
What does the data say?
Before looking ahead, it is important to check where we currently stand.
As discussed in previous issues of In-between the lines, the global economy
hit an air hole in the spring, triggered by the earthquake in Japan and
compounded by the surge in oil prices, emerging market tightening and the
Euro debt crisis. Global industrial production fell in March and April
together by about 1.2%. As predicted, that drop was reversed in May and
June. So far there are few July IP reports available, but early
indications are that production continued to rise modestly. That is also
consistent with the stronger July US labor market report, which suggests
that especially the car sector did better, and the pickup in Chinese
exports.
Looking through the volatility, however, the data also shows that the
underlying growth trend has slowed. That is consistent with the decline in
industrial surveys (PMIs) worldwide. The question is whether this
moderation leads to recession, as equity markets are increasingly
anticipating.
Fiscal tightening is a reality and not a forecast
The development of the sovereign debt crises in Europe and the US have led
markets to conclude that fiscal tightening will squeeze economic activity
to such an extent that this will lead to recession in both regions. We
agree that fiscal consolidation will be a drag on growth, but highlight
that this is nothing new. Government spending in the US, for example,
dropped 2% during the first half of the year. Government employment
already fell by more than 1% last year and the decline accelerated to a run
rate of 2% by the middle of this year. That was a massive drag on growth,
yet did not lead to recession despite the additional squeeze from the
global production plungein the spring. Last week's debt agreement implies
that fiscal consolidation will continue this year and next, but the implied
pace does not exceed what was already a reality in the first half of this
year.
Fiscal tightening in Europe's troubled economies is much more severe than
that in the US. Greece and Portugal are in recession and Italy and Spain
at the brink. However, that is also not new and has so far not derailed
the healthier parts of Europe, notably Germany.
Ripe for recession?
Fiscal tightening in the US and Europe will be a drag on growth for a long
time and that will have unpleasant labor market implications, but is not
enough to lead to recession. Moreover, other economic conditions are not
ripe for a recession. In the past, recessions have always been triggered
by a massive tightening in interest rate and lending conditions at a time
when credit-intensive demand was particularly buoyant. That is not the
case at the moment.
- The last recession was so severe because credit-sensitive spending was
buoyant prior to the crisis in both the US and Europe. Investment
collapsed subsequently and the recovery so far has been slow.
Investment rates are still close to the bare minimum, which implies
many companies are not investing much more than for replacement needs.
- The equity crash has so far failed to lead to a wide-spread tightening
in financial conditions. Interest rates are low and even declined.
Bank lending standards have improved over the last year and there are
no signs that they are tightening in response to the turmoil.
Central banks to the rescue
However, a sluggish economy is more vulnerable to additional shocks and the
current equity crash has the potential to be a trigger. We believe the
probability of recession is far less than the 50% anticipated by markets,
but not insignificant and rising the longer the turmoil lasts. The equity
crash will have negative wealth and sentiment effects, which should become
visible in August PMIs and consumer confidence figures. That could be a
short-term blip, but the risk is that sentiment deteriorates further, with
more severe economic implications. Policymakers, especially central banks,
will have to ensure that this does not happen. We expect further policy
action and in our base-case scenario assume that this will prevent an
escalation.
ECB and Fed have already made important moves. For the ECB, the
normalization policy is off the agenda and the next move is more likely to
be a cut than a hike. Although reluctant, the ECB will probably continue
its intervention in the bond market, but the EFSF needs to get up to speed
quickly to take over. QE3 is not off the list of possible Fed measures.
Also possible is that the Fed may again accept stocks as collateral in its
Primary Dealer Credit Facility. Last but not least, monetary tightening in
emerging markets has probably reached an end. In reversing policy,
important for all central banks are signs that underlying inflationary
pressures are abating, as was the case in China this week.
Disclaimer
This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor,
and was first published 16 August 2011, Silvia Quandt Research GmbH,
Grüneburgweg 18, 60322 Frankfurt is responsible for its preparation. German
Regulatory Authority: Bundesanstalt für Finanzdienstleistungsaufsicht
(BaFin), Graurheindorfer Str. 108, 53117 Bonn and Lurgiallee 12, 60439
Frankfurt.
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concerning the analysis of financial instruments (Finanzanalyseverordnung):
Number of recommendations Thereof recommendations for issuers to which
from Silvia Quandt Research investment banking services were provided
during
GmbH in 2011 the preceding twelve months
Buys: 96 37
Neutral: 41 1
Avoid: 5 0
Company disclosures
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in combination with the German regulation concerningthe analysis of
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