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THE GLOBAL ECONOMY: TERROR ON TOP OF RECESSION

THE GLOBAL ECONOMY: TERROR ON TOP OF RECESSION. Klas Eklund, SEB SNS, October 23, 2001. STARTING POINT: OECD INDUSTRY IN RECESSION. US PRE-TERROR: BOTTOMING OUT?. THE KEY: CONSUMER CONFIDENCE. RISING UNEMPLOYMENT. US CYCLE, PRE-TERROR. Y-o-y percentage change. 6. 6. 5. 5. 4.

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THE GLOBAL ECONOMY: TERROR ON TOP OF RECESSION

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  1. THE GLOBAL ECONOMY:TERROR ON TOP OF RECESSION Klas Eklund, SEB SNS, October 23, 2001

  2. STARTING POINT: OECD INDUSTRY IN RECESSION

  3. US PRE-TERROR: BOTTOMING OUT?

  4. THE KEY: CONSUMER CONFIDENCE

  5. RISING UNEMPLOYMENT

  6. US CYCLE, PRE-TERROR Y-o-y percentage change 6 6 5 5 4 Forecast SEB 4 3 3 2 2 1 1 0 0 00 01 02 03 Sources: EcoWin, SEB

  7. THE ATTACKS: IMMEDIATE EFFECTS • In a macro perspective, small material damage: 0.1-0.2% of GDP • But nonetheless recession in Q3-Q4 • Losses in communications sectors, finance, tourism, retail, etc • Supply chain broken • Financial markets: Flight to safety • Central banks in successful concerted action to guarantee liquidity • Steeper yield curves: Short rates fall, while bonds are affected by opposite forces

  8. STOCK MARKET: DOWN AND UP

  9. YIELD CURVE: STEEPER

  10. NOW: AN INTERIM STAGE • Consumer confidence and retail sales down • Important industries severely hit • Monetary and fiscal stimulus in the US • Building broad political coalition, ground troops on their way • The future will be decided by military/ political developments and effects on consumer confidence - and how this affects the fragile recovery

  11. THREE SCENARIOS • Quick solution • Earthquake scenario • Drawn out conflict • Gulf War scenario • The ugly case • Dramatic escalation of conflict Remember: Our starting point was below consensus

  12. SCENARIOS Y-o-y percentage change 6 6 5 5 4 Forecast SEB 4 3 3 2 2 1 1 0 0 00 01 02 03 Sources: EcoWin, SEB

  13. 1. THE QUICK SOLUTION • Successful retaliation • No further terror attacks; the Anthrax scare fades away • Low oil price • Confidence restored after some months • Fiscal stimulus works well • Stock markets rebound • Very short recession: Economic recovery in 2-3 quarters

  14. When? Before Sep 11 Immediately after Now discussed Sum new initiatives Total stimulus What? How much? Tax cuts 40 Emergency relief 40 Guarantees 15 Military spending 35 Special stimulus 60-75 150-175 Around 200 US FISCAL INITIATIVES

  15. NEGATIVE SHOCKS 0.5% higher unemployment: 1.0% 20% decline in stock market: 0.7% Global repercussions: 0.5% Total negative impact: 2.0-2.5% POSITIVE SHOCKS Fiscal easing: 1.5% Monetary easing: 1.0% Total positive impact: 2.5% IMPACT OF SHOCKS2002 GDP impact

  16. US GDP IN “EARTHQUAKE” SCENARIO Y-o-y percent change Per cent Per cent 6 6 5 5 4 4 Forecast SEB 3 3 2 2 1 1 0 0 -1 -1 00 01 02 03 Sources: EcoWin, SEB

  17. 2. A DRAWN-OUT CRISIS • Limited success in retaliation • The broad coalition breaks down • Risks of more terror attacks • Stability in the Middle East is threatened. Oil prices move up • Equity prices decline further • Consumer confidence takes a hit • Over-capacity remains a great problem; continued cuts of personnel and capex • Economic recovery is delayed until 2003

  18. EVENT 1973 Oil shock 1980 Credit squeeze 1987 Market crash 1990 Gulf war 1998 LTCM collapse CONFIDENCE - 53 - 36 - 15 - 47 - 19 CONSUMER CONFIDENCE:PREVIOUS EXPERIENCES

  19. CONFIDENCE NOW...

  20. …AND TOMORROW?

  21. SAVINGS RATE MOVES UP • According to IMF (2001), US personal savings have been lowered by: • Higher equity wealth • Higher public saving • Higher per capita Medicare transfers • Improved household access to credit • Lower inflationary expectations • Major influences now point to increasing savings • 1% change of savings ratio means 0.7% change of GDP

  22. SAVINGS RATE AND STOCK MARKETS

  23. RICARDIAN EQUIVALENCE

  24. US INDUSTRIAL PRODUCTION

  25. CAPACITY UTILISATION

  26. NEW ORDERS

  27. INVESTMENTS

  28. DEFAULT RATE(High yield, Emerging markets, Convertibles)

  29. STOCK MARKETS • Many claim the Fed model showed “fair value” before Sep 11 • That claim was based on optimistic earnings estimates for 2002 • The 64,000 dollar question: What is priced in? • If earnings estimates are overly optimistic - then the recent market rebound is a false start

  30. EARNINGS ESTIMATES

  31. US GDP IN “GULF WAR” SCENARIO Y-o-y per cent change Per cent Per cent 6 6 4 4 Forecast SEB 2 2 0 0 -2 -2 00 01 02 03 Sources: EcoWin, SEB

  32. 3. THE UGLY CASE • Escalation of terrorist attacks and retaliation. Attacks spread to Europe. • Many Muslim countries hostile to the US and its allies. The Saudi House is toppled and Pakistan (nuclear state) turns militant Muslim supporting the Talibans • Oil supplies in disorder and prices soar • More fiscal and monetary stimulus, but inflation fears push up bond rates and savings ratio rises

  33. EFFECTS ON EUROPE • Europe is not insulated • Several economic transmission mechanisms • Direct trade links • Stock market links • Consumer confidence • ECB will cut further • Some fiscal stimulus - but careful • Conclusion: Euro zone will follow the US, but the amplitude will be smaller

  34. JAPANESE TRIPLE DIP • Deflation, banking sector crises, debt explosion • Structural reforms, NPL solution and monetary policy must be co-ordinated • Reforms in the pipeline - but only slowly • BoJ prints money • Deep recession 2001-02, slow recovery earliest by 2003 • Is Koizumi Thatcher or Gorbachev?

  35. EMERGING MARKETS • Increased risks; premium high • Tourism severely affected • China strong: WTO and reforms • Rest of Asia: Mixed picture • Eastern Europe relatively stable, but Poland in crisis • Turkey: A drawn-out crisis • Argentina: Large or small default? Devaluation or dollarisation? • Contagion effects?

  36. GROWTH IN DIFFERENT SCENARIOS 2001 2002 2003 US“Earthquake” 1.0 1.5 3.5“Gulf” 0.8 -0.3 2.9 Euro zone“Earthquake” 1.5 1.7 2.6“Gulf” 1.4 0.7 2.6

  37. CONSENSUS FORECASTSGDP forecasts for 2002

  38. HUGE UNCERTAINTY • New prel. OECD forecast 2001-2002: • US 1.1% and 1.3% • Japan -0.7% and -0,8% • Germany 0.7% and 1.0% • OECD 1.0% and 1.2% i.e close to SEB’s “earthquake” scenario • Analysts’ forecasts wildly scattered • standard deviation doubled • On the V side: Goldman, Deutsche • On the recession side: CSFB, MSDW

  39. V SCENARIO PROBLEMS • Even if the effects of terror attacks per se look like a V, they come on top of a weak US economy • Fed cuts are counteracted by lower credit quality and falling investments... …and tax cuts by higher savings • Profit margins are low • Even if the US effects were to be mild, the risks of a global recession increase • Japan is on the brink • Emerging markets slide

  40. “It is surely wishful thinking to hope that the bursting of one of the biggest financial bubbles in history, combined with the aftershocks from the most serious attack ever on America’s soil, will be followed by the mildest recession in history” The Economist, Oct 20 WISHFUL THINKING?

  41. MULTIPLE EQUILIBRIA? • Best case scenario still pretty good • But worse case significantly worse • Risk-weighted outcome may not follow normal distribution • Several likely outcomes, depending on small shifts • Will make market adjustment jittery

  42. SUMMARY • US and Japan are moving into recession, Europe more resistant • The consensus view is a rebound early next year. But do not preclude a drawn-out recession! • The problem is the combination of • hangover from a burst bubble • psychological effects of terror • global interaction • Volatile stock markets, risk of a false start. Steep yield curves

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