Bloomberg gives us a pretty downbeat assessment from the Government of Singapore Investment Corp. (note that Singapore has two sovereign wealth funds, the other being Temasek):
Government of Singapore Investment Corp., a sovereign wealth fund that manages more than $100 billion, said the world economy may be facing its worst recession in three decades as the U.S. credit crisis spreads.
“We could be facing a recession which is longer, deeper and wider than any recession that we have encountered in the last 30 years,” Tony Tan, deputy chairman of GIC, as the company is known, said in a speech to more than 500 employees in Singapore today.
The International Monetary Fund earlier this month cut its forecast for global economic growth this year and said there’s a 25 percent chance of a world recession, citing the worst financial crisis in the U.S. since the Great Depression.
The world economy will expand 3.7 percent in 2008, the slowest pace since 2002, according to the IMF. In January the fund projected growth of 4.1 percent. The reduction is the third by the Washington-based lender since last July, when it predicted the world economy would cope with the U.S. credit squeeze and grow 5.2 percent this year…..
GIC has invested about $18 billion in Citigroup Inc. and UBS AG as banks raise capital after writing down investments linked to the U.S. subprime market. GIC is studying an additional investment in UBS through a rights offer after the bank wrote down a further $19 billion. Tan said today the investment in the two banks is “long term.”
Um, wonder if “long term” means that’s how long they expect it will take them to be made whole.
A more positive view comes from Tim Duy at Economist’s View, who argues that we may be near to a bottom in the economic downturn. Even if that proves to be true, note that the dot come bust recession ended as of 4Q 2001, but credit spreads remained elevated for the next year. Markets don’t always anticipate recoveries, as Barry Ritholtz reminds us. And Duy’s forecast is far from optimistic: while he expects the downturn to be shallow, the recovery will be anemic.
It is easy to fall into “the world is ending” trap. But economic downturns do not last forever, and the current episode is no exception. Ever since last summer, the yield curve, particularly the 10-2 steepness, has been sending a signal that I find difficult to ignore – a signal that the technical recession will be rather shallow and short-lived. Indeed, the 10-2 spread currently is consistent with the end rather than the beginning of a downturn:
Converted this into recession probabilities, the spread predicts improving conditions throughout the year and into 2009:
Just to be clear, while the technical recession may be relatively short lived, I am not optimistic about the other side of this downturn – no V-shaped recovery is in my forecast. Instead, I look for something between the U and the L shapes. My baseline scenario is that housing starts move sideways after bottoming, neither contributing nor subtracting from GDP. The housing sector will likely remain in disarray until prices contract to their historical relationship with incomes. Assuming the mortgage industry returns to historical underwriting conditions, the capital simply will not be available to support prices higher than roughly 3 times local median incomes. I have trouble seeing a way around such a constraint short of continued, substantial taxpayer support that would effectively amount to a policy decision that the average household should be expected to devote 40-50% of its income to housing costs. I really cannot see this as a socially optimal outcome, and I expect that it would be met with a backlash sooner than later.
Similarly, I expect the job market to remain challenged; recall the period of soft job growth though 2004 following after the technical end of the previous recession….
I anticipate the current cycle to be similar. Jobs will continue to be shed in the housing sector as capacity falls in line with a reduced demand. Moreover, these displaced workers will not easily regain employment in expanding sectors such as health care or export industries. Soft job growth and declining access to credit via home equity should keep a lid on consumer spending growth, similar again to the post-2001period….
So how does one reconcile the so-so ISM data with the consumer data, the latter of which is more clearly dire? Again, I believe the data reflects an adjustment away from a growth path that depends upon the external imbalance. A portion of the consumer slowdown will be off-shored to foreign producers, and exporters (primarily manufacturers) will benefit from the weaker Dollar. The consequence should be a relatively muted downturn and an expected improvement in the current account deficit….
Best that this adjustment occurs slowly, considering the enormous pressure on the consumer already evident from the gradual improvements to date. Of course, the slower the pace of the adjustment, the longer as well (again, somewhere between the U and L-shapes), and therein lays the danger for policy. Policymakers will be hard pressed to allow the process continue unabated, as they lack the courage to tell Americans that the country needs to learn to live within its means. Given a growing populist sentiment on the back of stagnating median incomes, I see little but a river of red ink from the Federal government…..
Bottom Line: I suspect the cessation of rate cuts is near at hand. The Fed will likely pull the trigger on another 25bp at the next FOMC meeting, and send a signal that they intend to pause soon. I believe they could pause now, but see this as unlikely given their tendency toward dovishness of recent months. Another 25bp in June is not out of the question, but I think unlikely as well. It will soon be time to turn our attention to timing the next tightening cycle. Expected job market/housing weakness argues for an extended period of low rates similar to the last cycle; continued strength in commodity prices argues for a more rapid reversal of recent policy. I believe that a rapid reversal of policy will be politically difficult for the Fed given that Congress will tend toward resisting any protracted structural adjustment that is painful for US households.
Duy and the markets are on the same page as far as the outlook for further Fed cuts is concerned. The central bank’s continued timidity is a shame. If the Fed had the nerve to forego a rate reduction at the end of April, that could reveal a good deal as to how much of the rise in commodities was driven by speculation (Jim Hamilton has argued forcefully for holding pat).