This is a square root shaped recovery
HERE are some more weird and wonderfully expressive ways of describing the economy over the next few years. Yesterday, the Institute of Directors (IoD) warned of an “L of a recovery” – though the horizontal bit would actually boast a slight upward gradient, denoting weak rather than zero growth. But the IoD is also floating the possibility of a (far more exciting) square root shaped recovery. In this scenario we would see an acceleration in GDP growth in the second half of 2010, which will combine with sticky inflation to trigger an interest rate hike or a reversal of quantitative easing (QE) by the Bank of England (by the way, the opposite of QE is QT – or quantitative tightening, which may or may not happen on the quiet). The result is that GDP growth quickly levels off and instead of an L the cycle looks more like a square root symbol.
There was more evidence yesterday that the global economy is slowing a little – yet that the outlook is one of a stuttering recovery (Societe Generale’s phrase) rather than a double-dip. The US ISM non-manufacturing index fell to 53.8 in June, from 55.4, adding to concerns. Of course, any reading above 50 implies growth so there is still a decent expansion going on. Other countries have seen falls in similar indices: China’s manufacturing purchasing managers index is down from 53.9 to 52.1. But that survey’s long-term average for China has been just 53.4, a rate which went hand in hand with extraordinary expansion. A sharp slowdown, sure, but no hard landing yet.
As Bank of America Merrill Lynch reminds us, the slope of the yield curve (which shows how the interest rate changes depending on the maturity of government bonds) is the best single indicator of recession risk. The US yield curve has inverted ahead of every postwar recession (ordinarily, the interest rate on short-term bonds is lower than on long-term bonds, because of the extra risk and uncertainty entailed with any long-term contract; this maturity gap switches in recessions). Even with the drop in yields in recent weeks, the yield curve remains extraordinarily steep and thus is predicting a boom, not a bust. The data is similar in most developed economies. I’m sure we won’t be getting a boom – but again, no evidence here of a double-dip, as I’ve been arguing for the past several days.
One more piece of data, courtesy of Evolution Securities: most post-war US recessions – including that of 2008/09 – have been preceded by profits declines. Company profits, however, rose strongly in the first quarter and are likely to have continued to have done so in the second, the reporting season will confirm.
It is equally not the case that everyone is slowing together: in a clear case of decoupling, one country that is enjoying an almost strange spurt is Japan: SocGen has hiked its growth forecast from 1.9 per cent to 2.8 per cent in 2010 and from 1.8 per cent to 2.2 per cent in 2011. I’m no bull (in fact, I hate the species) but the bears are overplaying their case – unless, of course, the Eurozone were to collapse and make the sub-prime crisis look like a Tea Party. Other risks include a major geopolitical catastrophe – we have all become too complacent about terrorism. But barring these kinds of events, we should all plan for 1-2 per cent growth a year for the time being, still low interest rates, sharply tightening fiscal policy and an increasingly regulated credit supply. Welcome to the new normal.
allister.heath@cityam.com