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US Regional Watch

840142f1-03e4-4c00-a378-879c0e80ec1e

11

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3rd Quarter 2009

Mon, Sep 21 2009, 13:56 GMT
by BBVA Bancomer Team

BBVA Bancomer

In this issue you'll find:

• Global Outlook
• U.S. Economic Outlook
• Savings Rate & Economic Trends
• BBVA Compass Sunbelt Region Outlook
• State Finances: Rough Times Ahead
• Potential Output Growth in the BBVA Compass Sunbelt Region
• Housing Market: Signs of Stabilization
• Commercial Real Estate: Recovery Remains Far-off
• The Arizona-Sonora Border Region
• Leading Colorado out of the Recession
• Credit Unions, Small Banks & Industry Trends
• Fact Sheet
• Forecasts

Global Outlook

The global economy is coming out of the recession but doubts remain about the sustainability of the recovery and the strength of growth in coming years

Recent data confi rms that the global economy is progressing towards stabilization. Incoming second quarter activity data show that in nearly all countries the rate of decline is moderating and, in some cases, the economy is in fact growing when compared to last quarter. In the U.S., GDP showed a lower-than-expected quarterly fall in the second quarter. Also, many developing countries recovered positive quarterly growth rates in the second quarter or accelerated growth (China). The huge support from policy packages and the continuing fall in fi nancial tensions are behind this recent improvement of activity.

A key aspect of this positive cycle has been the policy response to the crisis by governments around the world. In both developed and emerging countries, governments implemented several monetary and fi scal policies to mitigate fi nancial distress and to fi ght recession and defl ation risks. On the monetary side, Central Banks have utilized expansionary policies (conventional and non-conventional), lowering interest rates to historical minimums and taking several measures to increase liquidity. On the fi scal front, governments implemented expansionary fi scal policies that were very useful in avoiding further declines in the already depressed aggregate demands. The effects of these policies were especially felt in the second quarter, and are one of the drivers behind the recent better-than-expected activity data.

The improvement of fi nancial conditions began at the end of the fi rst quarter and continued through the second quarter. Banks’ credit default swaps in the U.S. and EMU are at pre-Lehman failure levels. Interbank markets have also experienced important corrections in the last months, with 3-month OIS spreads at their lowest levels since early 2008. A resurgence of optimism has also been perceived in the stock markets, with general increases both in developed and emerging countries. The reduction of fi nancial tensions generated further optimism from investors and consumers, as refl ected in many confi dence surveys.

In spite of this general optimism, it is still too early to assure that the recovery will be sustained as the risk of a “double-dip” recession remains a remote possibility. Regardless, the recovery is expected to be sluggish. Some of the forces that will provide a drag on the recovery are: (1) fi nancial systems remain fragile in many countries, with banks still waiting to be restructured and their balance sheets cleaned; (2) the strong support from fi scal policies will diminish next year; (3) households will continue increasing savings and moderating consumption, (4) high unemployment which may become structural through hysteresis effects will further depress consumption; (5) global trade may take several years to recover its pre-crisis importance.

Emerging countries surface less damaged from global crisis

While the abrupt fall in international trade was particularly damaging for small and open developing countries with a small internal market, in general, emerging countries have been affected less than developed ones by the global fi nancial crisis. For instance, China, the biggest emerging economy, showed an impressive growth record in the second quarter of the year, after the slowdown registered in the last quarter of 2008 and in the fi rst quarter of 2009. This high growth is based on an exceptional easing of bank credit, a massive fi scal plan implemented by the government and a better-than-expected behavior of internal demand that partially compensated the fall in external demand. The rest of Asia also registered improved activity data in the second quarter, with positive GDP growth in 2Q09 which contrasts with the contraction registered in 1Q09.

Latin America was hit hard in the fi rst quarter from the fall in global trade, an initial decrease in commodity prices and the increase in external fi nancing costs. However, the region, led by Brazil, has resisted the impact better than in previous crisis because it was in a stronger fi scal and external position with a more solid fi nancial system, which left room to implement countercyclical policies. As a result, they will probably suffer a comparatively moderate recession this year. In contrast, Eastern European countries were particularly affected by the crisis, with double digit year-over-year (yoy) falls in GDP in the fi rst quarter (notably in Turkey and Ukraine). The combination of a weak external and fi scal position, with large “twin defi cits”, and important vulnerabilities in their fi nancial system, imply that the region is particularly vulnerable and that the recovery will be much more diffi cult.

During the second quarter, as the perception that the global recession was receding and fi nancial tensions decreased in central economies, risk appetite increased in global fi nancial markets and many emerging economies exhibited impressive stock market rises, currency appreciation and capital infl ows. The recovery of commodity prices has also propelled stock markets and currencies in many countries.

In coming quarters, the sustainability of the recovery and the strength of growth potential of developed economies will be the key elements to watch

Activity is stabilizing, but it is probable that it will remain subdued in many economies. Of particular importance is whether private consumption and investment will be able to replace government consumption in stimulating demand, once the huge fi scal packages implemented begin to recede. Rising unemployment will depress consumption and activity. As well, concerns about fi scal sustainability underline the need for solid fi scal policy frameworks in the coming years. The manner in which the fi scal adjustment will be implemented will also have differing consequences on the shape of the recovery, and extra care should be taken to avoid a “double-dip” recession.

Monetary policy is expected to be expansive until solid growth is underway and defl ationary risks recede. In this sense, despite some upward pressure from recovering commodity prices, global infl ation is expected to remain subdued, held back by signifi cant excess capacity. This implies that interest rate hikes are unlikely until 2011.

In the long run, the health of each country’s fi nancial system will be a key aspect to monitor. The shape of the fi nancial system that will emerge from the crisis will determine the profi le strength of growth in coming years.

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Published on  Mon, Sep 21 2009, 14:05 GMT