Highlights

  • US employment collapses in September and October

  • IMF forecasts GDP decline in industrialized countries in 2009

  • G20 summit meeting unlikely to produce tangible results


The “Big Three” directionless

The protracted financial crisis is having a marked impact on the real economy worldwide. The third quarter was weak, but it looks as though the fourth quarter will be even weaker. The current data are alarming: in the US, the ISM index for the manufacturing sector plummeted from 49.9 in August to 38.9 in October, thus indicating a sharp contraction. Levels have not been so low since the recession at the beginning of 1991. The service sector is not faring much better either: in October, the ISM non-manufacturing index fell to 44.4 – its lowest level since the survey started in 1997. It is worrying to see that the situation on the US labour market is deteriorating rapidly.
Surveys, initial jobless claims data, company reports: they are all indicating that more and more jobs are being cut.

In Europe, the employment market has not yet been affected as much. In the EU as a whole, the unemployment rate only rose slightly up until September from 6.8 to 7.0%, in the eurozone from 7.2 to 7.5%. However, in some countries, things are looking much worse: in Spain, unemployment has been rising constantly during the last 16 months from 8.0 to 11.9%. In Ireland, the unemployment rate has increased from 4.6 to 6.6% in the last 12 months. In the UK, it has gone up from 5.0% last November to 5.6%.

The employment situation in other parts of Europe has remained robust up to now, but this should not lull us into a false sense of security: some economies – including Germany – still had fat order books which kept them going up until summer. These reserves are now coming to an end. According to the results of the EU Commission’s survey of industry, over a quarter of the companies are now saying that their order books are too thin. And things are looking gloomy, as far as industrial new orders are concerned too.
The German producing sector recorded an 8% plunge in September; the average volume of orders in the third quarter was almost 5% lower than in the same quarter of last year. Things are going the same way in the eurozone: industrial new orders are likely to have fallen for the third consecutive quarter.

From a global perspective, things are not much better. Only a few weeks after the World Economic Outlook was published, the International Monetary Fund felt obliged to revise its growth forecast down again. Now the IMF is expecting a GDP drop of 0.3% (as opposed to an increase of 0.5% previously) in industrialized countries in 2009. If this forecast proves to be correct (and we ourselves are even more sceptical than the Fund), it would be the first time that GDP declines on an annual basis in the industrialized countries since the end of World War 2. For the developing countries and emerging markets, the forecast was cut by 1 percentage point to 5.1%. The reasons for this were weaker demand from industrialized countries, the collapse in commodity prices and investors’ retreat from emerging markets. Asian currencies in particular are facing a massive appreciation against the euro and other European currencies.

The rapid deterioration of growth prospects, diminishing inflation risks as a result, and the financial market crisis looming in the background have prompted central banks to slash interest rates. Last week, the Fed had already lowered its central bank rate to 1.0%; this week the Bank of England, the ECB and the Swiss National Bank made further interest rate cuts. The BoE shocked markets with a radical cut: in view of weak economic activity, – after stagnating in Q2, real GDP fell in Q3 by 0.5% quarter on quarter – and frightening constraints in lending, it cut the bank rate by 150 bp to 3.0%. The ECB, however, only lowered the refi rate by 50 basis points to 3.25%, as had been generally expected. The SNB also lowered the 3-month Libor target rate by 50 bp to 2.0%.

The interest rate cuts had very little impact on the forex markets. After the first shock, the pound actually gained slightly in reaction to the Bank of England’s step. Market participants are evidently firmly convinced that the industrialized countries are in the grip of a crisis and that, within a very short time, central bank rates in Europe will be cut to similar levels to US rates. For the forex markets, it does not really matter whether this happens in two, three or four steps.

Like last week, exchange rate movements were relatively slight this week too. At the end of the week, the euro firmed to slightly under 1.28 against the US dollar. CAD, AUD and NZD all posted slight gains. USD-JPY ended the week at about the same level as the previous week, at around 97.20. Emerging market currencies (HUF, PLZ, TRY, ZAR, KRW, BRL) were somewhat weaker, losing 2 to 3%. The Czech koruna dropped a bit more: the turmoil of the last few weeks had not affected it much, but the exchange rate was now probably reacting to the deterioration in the economic outlook and the unexpectedly sharp repo rate cut on Thursday by 75 bp to 2.75%.

We are not expecting major exchange rate movements among the Big Three in the near future. We are under the impression that the markets are following fundamental, macroeconomic developments more closely again – looking for signs as to how deep and protracted the recession will be. However, no new revelations are expected for the time being. The dollar is suffering a bit as a result of the weakening labour market in the US; the negative surprises in the October labour market report (released today) could make themselves felt at the beginning of next week.
During the course of the week, developments in Europe are likely to be in the spotlight: on Wednesday, the German GDP figures for Q3 will be published; the Italian, French and eurozone figures will follow on Thursday. We are expecting a slight contraction of economic activity across the board, which would confirm the recession and limit the euro’s upward potential.

At the weekend, the (extended) G20 group are meeting in Washington to discuss the consequences of the financial crisis and possible ways to reform the international financial system. The discussion is focused on financial supervision: involving players and products more; tightening and harmonizing standards; co-ordination and exchange of information between the supervisory authorities, and also the potential role of the IMF or other institutions. There is, however, a considerable clash of interests among the participants. It is all about national versus supranational competences; about influence on institutions and authorities such as the IMF; about financial centre interests and basic economic policy convictions.
Furthermore, the US government is not fully functional at the moment, and the Europeans cannot agree amongst themselves. We are therefore expecting a full programme of working groups and summit meetings to be arranged, but nothing tangible to emerge for the time being.