The BBB recovery | FT Alphaville

The BBB recovery

An early morning helping of doom and gloom, courtesy of Morgan Stanley, which has cut its global growth forecast for 2011-12 by a full percentage point.

The bank – one of the more bearish houses on the Street – reckons the US and Europe are dangerously close to recession because of fiscal tightening and policy blunders, while the slowdown in emerging markets growth, caused by a run-up in inflation and the monetary policy response, now looks set to be prolonged.

However, there are a couple of positives. This isn’t 2008, the fall in the oil price should act as a stabiliser, and companies are sitting on piles of cash and (for now) making healthy profit margins. But, the bank says, it wouldn’t take much to tip the developed world over the edge into another recession.

For now the ‘recovery’ is in the words of Morgan Stanley’s Joachim Fels, BBB — Bumpy, Below-par and Brittle than previously thought.

Edited lowlights.

1.We cut our global GDP growth forecasts by a combined full percentage point in 2011/12, to 3.9% combined full percentage point in 2011-12, to 3.9% from 4.2% in 2011, and to 3.8% from 4.5% in 2012. We now see growth in the developed market (DM) economies averaging only 1.5% this year and next (down from 1.9% and 2.4% previously). While we had been calling for a BBB recovery in DM all along, the path now looks even more bumpy, below-par and brittle than previously thought. EM economies won’t be immune to the DM slowdown, in our view. We now see EM growth decelerating from 7.8% in 2010 to 6.4% this year (6.6% previously), and further to 6.1% (6.7%) in 2012. While this keeps EM GDP cruising above its 20-year trend rate of 5%, it implies a significant further cooling of growth compared to last year’s bonanza.

2. A policy-induced slowdown. There are three main reasons for our downgrade. First, the recent incoming data, especially in the US and the euro area, have been disappointing, suggesting less momentum into 2H11 and pushing down full-year 2011 estimates. Second, recent policy errors – especially Europe’s slow and insufficient response to the sovereign crisis and the drama around lifting the US debt ceiling – have weighed down on financial markets and eroded business and consumer confidence. A negative feedback loop between weak growth and soggy asset markets now appears to be in the making in Europe and the US. This should be aggravated by the prospect of fiscal tightening in the US and Europe.

3. US and Europe dangerously close to recession: Our revised forecasts show the US and the euro area hovering dangerously close to a recession – defined as two consecutive quarters of contraction – over the next 6-12 months. The US growth disappointment in 1H11, when GDP advanced by an annual average rate of less than 1%, illustrates the brittleness of the US recovery in the face of external shocks (oil, Japan earthquake), despite ongoing QE2 and fiscal stimulus at the time. While the current quarter should still show some rebound in growth to around 3% from the very low bar in 1H, much of this rebound is likely due to temporary factors such as the ramping up of auto production as supply disruptions from the Japan situation ease. The most critical period for the US economy will likely be 4Q11, when we may see some fallout from the heightened volatility of risk markets, and 1Q12, when we get an automatic tightening fiscal policy if, as our US team currently assumes, this year’s fiscal stimulus measures will expire.

4. Europe’s woes to continue. The ECB’s past rate hikes and, more so, the sovereign crisis and the additional fiscal policy tightening as well as the banking sector funding stress it produces, will take an additional toll on growth, in our view. Our European team now sees euro area GDP broadly stagnating later this year and in early 2012. Thus, it won’t take much to tip the balance towards recession, especially as a final resolution of the debt crisis (in the form of fiscal transfers or common bond issuance) is likely to be very slow in coming. Against this backdrop, our European team has slashed its already below-consensus 2012 euro area GDP forecast from 1.2% to a mere 0.5%. In our view, despite the problems in the US, the euro area is clearly the weakest link in the global chain.

And finally…

7. EM policy makers to cushion the blow. The current slowdown in EM growth, caused by a run-up in inflation and the monetary policy response, now looks set to be prolonged into 2012 by the weaker DM outlook. However, with inflation at or close to a temporary peak, some policy easing in EM looks likely to provide a cushion for growth. EM policy-makers should be able and willing to help their own economies avoid a hard landing, but they won’t be able to bail out the world, in our view. Absent the kind of tail risks that were present in the world in 2008, and having barely emerged from a battle with inflation and overheating, EM policy-makers at this point will likely signal that they want to use just enough policy stimulus to help their own economies.

Related links:
Kaputt – FT Alphaville
Liberté, égalité, fraternité – FT Alphaville