Tuesday, January 19, 2010


For better or for worse
As the deepest economic and financial crisis developed economies have experienced since 1929 is drawing to a close, the review of the year cannot be limited to the unhoped-for performances posted in all markets. Of course, a systemic crisis has been avoided, thanks to the coordinated actions of governments and central banks.

Governments, first, provided the required guarantees to the banking sector to lift the mistrust prevailing in the interbank market until March, and, second, supported the real sphere that started to be hit head-on by the effects of the recession. Central banks succeeded in unblocking the funding of financial institutions, while trying to outdo each other in innovative measures.

2009 was the perfect illustration of the fickle nature of the markets. While the worst level was reached end-March in terms of valuation of risky assets, the first signs of cyclical improvement were interpreted as the signal of an incipient rally. Initially, there was talk about a bear rally, but then a downright bullish trend took root in all equity markets, while volumes were, however, limited at the outset. Once it was clear that the bottom had been reached, most investors returned to the equity markets, not wanting to "miss the rally", even though uncertainties hovered over the future of this asset class only one year ago. The market went from a regime of total risk aversion to one of almost unlimited appetite! That obviously does not justify talking about “irrational exuberance" again...

In the wake of the surprising year that was 2009, we will single out two themes that we will have to face in 2010: - Concerning the characterisation of the end of the crisis (V,
W, L, etc.), the market has settled for the V. However, what can the level of activity be in developed countries once the government stimulus packages have been spent? Whereas economic agents show a real determination to deleverage, is it possible to rely on China and emerging countries to drive global growth?

- The recession has technically been over for several months, but it has left two significant macroeconomic imbalances in its aftermath. First, central banks' balance sheets have reached stratospheric levels, as they are pumping overabundant liquidity into all markets. Mopping up this liquidity and the first normalisations of key rates will be tricky exercises. Second, governments ended the year with huge fiscal deficits likely to penalise bond markets somewhat more, or even resulting in risks of sovereign defaults.

Macroeconomic context: Paradigm shift in the United States, resilience in Asia
The recession was far stronger than expected. While we expected, according to the region, a stagnation at best, if not a fall in activity, the reality proved to be far worse: according to our estimates, global economic growth (Chart 1 - economic situation section) declined in 2009 by 2.5% (-1.3% in PPP). This deterioration is explained by: (i) the fall - or even a halt - in international trade (Chart 2); (ii) the halt in credit at the
beginning of the year, whether due to the determination of private agents having to deleverage (Chart 3) or banks facing funding problems; (iii) the continued drop in investment, especially in real estate in most OECD countries (Chart 4). The Asia zone (China and emerging Asia, Chart 5) stood out in particular, posting positive growth in 2009.

Thus, US GDP dropped by 6.4% in the first quarter (in annualised Q/Q terms). At the peak of the crisis, the US economy destroyed in excess of 740,000 jobs in one month.
The reason why the move was particularly marked in the United States was because the crisis put an end to the debt economy. Households should prove to be far more cautious in the future, bringing their consumption to levels more in line with the fundamentals. The reason is that the outlook for households has been ruined by the wealth shock caused by the crisis (financial and real estate, Chart 6) and the recession, which is accompanied by a sharp and long-lasting deterioration in the labour market (Chart 7). As a corollary, the savings rate reached 4.7% at year-end. We have to go back to before 1998 to find such a high level (Chart 8)!

In the United States, the favourable counter-cyclical factors such as fiscal stimulus (USD 270 bn spent in fiscal year 2009), the expansionary monetary policy (see below) and disinflation nevertheless enabled the US economy to enjoy renewed growth from the second half. Technically, the end of the recession was confirmed in Q3-2009, thanks to a rebound in residential investment (+23.4% at an annualised pace) and consumption (+3.4% at an annualised pace). Companies also contributed to this recovery (lower destocking, slight rise in productive investment). This development remains to a large extent accounted for by the fiscal stimulus: the slowdown in wages is for the time being more than offset by the various transfers to individuals (car-scrapping incentives, tax credits, etc.).

To read the full report: FINANCIAL MARKETS