|US household net worth|
Global economy in severe recession, but US growth set to improve later this year
Every major economy faces sharp declines in GDP of 1-2.5% this year
But US growth set to get back into positive territory by year-end, helped by:
- An enormous $800bn-plus fiscal package from newly
inaugurated President Obama;
- the 'do-whatever-it-takes' approach of the Bernanke Fed;
- significantly lower oil prices; and
Relief on the way for Irish exporters as euro expected to fall
Early-year weakness for the euro has brought some relief to Irish exporters on the currency front
And we expect further declines against both sterling and the dollar
We have a near-term target of $1.15 for Eur/USD and an end-year forecast of 80p for Eur/Stg
Large declines in long-term rates provide excellent hedging opportunity
The major central banks have been cutting rates aggressively, and both the Bank of England and ECB are set to take rates down to new record levels of 0.75% and 1.50% respectively
Long-term borrowing costs have fallen sharply across all markets in tandem with the huge falls in official interest rates
We strongly encourage companies with long-term debt to use this window of opportunity to consider hedging their interest rate exposure at levels which are at or close to record lows
Simon Barry, Senior Economist, Ulster Bank,says in the Ulster Bank Quarterly Focus on Markets that the global economy is experiencing a severe and synchronised downturn which is being led by pronounced weakness in the world's major economies. The G7 block faces its first year of contraction since 1982 as every major advanced economy faces significant declines (of around 1-2.5%) in output this year – an extremely unusual pattern of pervasive weakness.
The US is facing its longest, though most definitely not its deepest, recession since the Great Depression of the 1930s. Exceptionally poor momentum, very weak confidence and dwindling order books leave the euro area economy poised to contract by as much as 2% in 2009 which would represent the weakest year for the countries that make up the zone since the 1930s. The UK, too, is looking at a brutal slump with a decline in real GDP of over 2% on the cards – the worst year for the UK since 1980.
One upside to a much weaker global economy is much lower commodity prices. Oil prices, for example, have fallen by more than $100 from last year's peak to around $45pb at present. This provides the dual benefit of providing a direct and badly needed boost to household and firm discretionary spending power, and also contributes to a vastly improved inflation outlook, thus giving the central banks plenty of scope to use monetary stimulus to arrest the economic decline.
The Fed has, for the first time in its history, taken its policy rate down to effectively zero and has now switched its focus to using a whole host of novel alternative measures to further boost the ailing US economy and financial system. The Bank of England's recent actions have also been bold, decisive and very aggressive. Its Bank Rate has been lowered by 3.5% in just over three months, action which leaves official rates at 1.5% - a level never before seen in over 300 years of monetary history in the UK.
The ECB is lagging behind the other main central banks in terms of its policy response. Its 2.25% cumulative reduction in rates so far this cycle is less than half that introduced by both the Fed and the BoE. Nonetheless, it is cutting rates faster than it ever has before and its cut last week to 2% has taken rates to as low as they have ever been in the institution's 10-year history.
It's not just on the monetary front that the US is leading the way. New US President Obama has a strong mandate, has assembled a heavy-hitting economics team and looks set to inject an enormous fiscal stimulus on an unprecedented scale (of the order of $800bn-plus) into the US which will provide considerable support to the economy and financial system there over the next two years. Fiscal policy has also turned very supportive in the UK, albeit not quite to the same extent. Meanwhile, in the euro area attempts at fiscal stimulus have been hampered by both institutional and philosophical difficulties. The authorities have struggled to put together a package that is either co-ordinated or meaningful, though the most recent indications have been more encouraging and suggest that Germany will now in fact proceed with a stimulus package (of the order of 1.5% of GDP).
The Obama fiscal plan, the 'do-whatever-it-takes' mentality at the Bernanke Fed, lower oil prices and a housing correction that can't and won't last forever, lead us to believe that the US economy will show signs of stabilising later in the year, and we pencil in a return to positive, if still below-par, growth rates by the end of the year. We also take encouragement from some thawing of conditions in credit and funding markets of late. International money markets have been showing heartening signs of improvement while US mortgage rates have fallen significantly in the past couple of months. However, events of recent days highlight that strains in the international banking system remain a major concern.
The UK and euro area will eventually follow the US out of recession, but likely in that order - reflecting the relative policy responses in the two economies. In the meantime, interest rates are likely to be lowered to yet more record lows of 0.75% and 1.5% respectively, with a risk of rates going even lower in both cases.
From a treasurer's perspective, we highlight that long-term borrowing costs have fallen sharply across all markets in tandem with the aggressive lowering of official rates by the central banks. In many cases, notably in the UK and US, rates are currently at record lows. 10-year dollar rates at around 2.5% stand out as exceptionally good value. While long-term rates may end up falling a bit more in the short term, we strongly urge those with long-term debt to use this window of opportunity to hedge any interest rate exposure at levels which are at or close to record lows. 5- and 10- year rates in euros and sterling at around 3% and 3.5% respectively represent the type of opportunity that rarely presents itself.
On the currency markets, we expect better news for Irish exporters to the UK this year following sterling's unprecedented and unwelcome 35% collapse against the euro last year. Greater focus on euro area rather than UK economic weakness this year provides scope for the Eur/Stg rate to continue to move lower in 2009. We target 80p by the end of the year, a move that would also be consistent with the market rewarding the policy-activism of the UK authorities both in absolute terms and relative to the euro zone. We also forecast more weakness for the euro against the dollar, in the short term at least, with a $1.15 target for the months ahead, though the greenback may find it difficult to sustain those levels later in the year.