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Friday Notes

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More action, please!

Fri, Apr 3 2009, 12:44 GMT
by UniCredit Research

UniCredit Group

• Missing links. Billions in bailout and economic stimulus programs, zero interest rate policy and quantitative easing – the list of economic policy achievements thus far is impressive. But the final touches needed to revive confidence and return the global economy to a growth path are an end to the meltdown in house prices and a convincing new global financial architecture.

• G-20 meeting. It is true that banks should be more strictly regulated, oversight improved, and funding for the international financial institutions increased. The summit did not, however, bring a breakthrough. The trans-Atlantic dispute over the scale of financial market regulations and the volume of stimulus measures will continue to smolder (p. 2-3).

• House prices. The unrelenting decline in house prices also remains a heavy burden for the global economy. It is hurting not only bank balance sheets but also private consumption via the wealth effect. Until house prices stabilize, an economic recovery is out of the question.

• US. Since autumn of 2007, US house prices have fallen 30%. A further decline of 15%-20% is in the cards by the end of the year. The reason for this is the still immense excess supply of homes. But there is at least a justified hope that the pace of the decline is slowing (pages 4-6 & chart).

• UK. The UK housing market is just a mirror image of the US market. Here too, the unprecedented meltdown in house prices will probably persist for a few more quarters. But there are at least initial signs that the pace of the price meltdown is slowing (pages 7-9).

• Further topics:

  – Weekly Comment: G-20 – Emerging Markets-friendly (page 2).

  – ECB: Maybe May (page 10).

  – Germany has auto shopping fever (page 12).

  – US: Credit crunch continues unabated (page 14).

  – Data outlook: EMU-wide industrial production to fall further (p. 17).

  – Market outlook: EUR in demand; bonds to move sideways (page 24).

G-20: Emerging Markets-friendly

Yesterday’s G-20 summit brought an important positive surprise in the scale of new resources made available to international financial institutions, and a major disappointment on all other fronts. The agreement to commit an additional USD 1.1 trillion in funds to the IMF (USD 500 bn) and other institutions seems to be in part to compensate for the complete lack of agreement on further fiscal stimulus at national levels. As I already argued, this raises the risk that we will have an unbalanced recovery following a prolonged slump. The final communiqué has a very strong emphasis on regulation, and while the general principles are sound (stronger and better coordinated regulation), the details sound more like a shopping list of the current favorite scapegoats (hedge funds, tax havens, bonuses). The other major disappointment is the lack of any detailed discussion of possible further steps to improve transparency and confidence in the financial system. The impression is that everyone is now hoping that Mr. Geithner’s Public-Private Investment Program will resolve tensions in the US financial system and have a cascading spillover effect across the globe. It is a hope that I share, but I would prefer to see G-20 countries stepping up joint efforts on this front, as without a normalization in the global financial system, the green shoots of recovery could quickly wither and die.

Overall, the communiqué is long on lofty principles and short on concrete commitments, and my impression is that EU countries were able to get most of what they wanted into the communiqué, whereas the US will take home very little, except the stronger commitment of resources through international financial institutions. In terms of market reactions, Emerging Markets (EM) should be the big winners, but I see nothing that can bolster more general confidence in a quicker recovery from the financial turmoil and economic downturn. The major positive surprise is the large boost of IMF funds which will be tripled to USD 750 bn, rather than just doubled. This is extremely positive for emerging markets, especially in Central and Eastern Europe, where external financing needs have been identified by investors as the Achilles' heel.

It is especially positive as it coincides with the successful launch of the IMF’s new Flexible Credit Line facility. Previous attempts to offer a contingent credit line to countries with good fundamentals as an insurance against worsening market conditions had systematically failed, as countries feared the associated stigma, namely that markets would see it is a signal of brewing troubles. This time, Mexico has broken the impasse by requesting a USD 47 bn credit line, and has been rewarded with a favorable market reaction, including a strengthening of the peso (cf. chart next column). This should open the way for more EM to follow suit. Contingent credit lines should work effectively as insurance policies, reassuring markets and lowering the risk of a collapse in confidence.

Moreover, G-20 leaders agreed on a new Special Drawings Right (the IMF’s synthetic unit of account) allocation of USD 250 bn; another USD 250 bn for trade finance; and USD 100 bn for lending by Multilateral Development Banks. This brings the total increase in funding for international institutions to an impressive USD 1.1 trillion. There was no agreement on the scope and distribution of further fiscal stimulus. This leaves completely unresolved one of the key issues: whether additional stimulus is needed to lift the world economy out of the recession, and how to share the burden to avoid a resurgence of global macroeconomic imbalances. As I already argued, this raises the obvious risk of an unbalanced recovery after a prolonged recession. There is a strong emphasis on regulation: the general commitment to strengthen not only the national regulatory systems, but also their harmonization and coordination, is encouraging; the details less so:

– The Financial Stability Forum will be succeeded by a Financial Stability Board including all G-20 countries, and charged to monitor macro-prudential risks together with the IMF.

– The G-20 call on accounting standard setters, regulators and supervisors to improve standards on valuation and provisioning and to achieve a single set of high-quality global accounting standards.

– Credit rating agencies to be subjected to regulatory oversight.

– Systemically important hedge funds to be regulated.

– Compensation schemes to be reformed and made “sustainable” according to the Financial Stability Forum’s “tough new principles”.

The communiqué includes a dutiful pledge to refrain from protectionist measures, including through fiscal policy and financial sector support measures, and to avoid financial isolationism and distortions in financing flows. Sticking to this commitment will be crucial not only to prevent a further contraction in global trade, but also to prevent a dangerous further reduction in financing flows to Emerging Markets.

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Published on  Fri, Apr 3 2009, 12:51 GMT