Economy Downgrades

According to the economics teams at three leading investment banks, the Australian economy is slumping right now and will continue to worsen well into 2009 at a rate lower than the forecasts from Treasury and The Reserve Bank.

The economics teams at Goldman Sachs JBWere and Merrill Lynch have slashed their estimates of 2008 and 2009 economic growth for Australia and are now predicting recession.

And ABN Amro reckons the economy is stalling right now and growth is close to zero.

They all agree that as a result the Federal budget will go into deficit, unemployment will rise to 7.5%, and the Reserve Bank will cut interest rates to a low of 3.5%, a point suggested late last week as well by Macquarie Bank interest rate strategist, Rory Robertson.

He and the two teams now say we will get a 1% cut in interest rates from the Reserve Bank at its meeting next Tuesday, which will take the cuts since September to 3%, a measure of how seriously the RBA views what is happening in the economy.

But debt futures market are tipping the RBA to cut the cash rate by a massive 1.25% next Tuesday, which if it happens, would be the largest official rate cut since the 1990 recession.

ABN Amro’s chief economist Kieran Davies said a shrinking Australian economy, falling asset prices and recession-like levels of business confidence will make the RBA more inclined to cut rates aggressively.

“The wealth effect of falling asset prices is snowballing and the Chinese economy is slowing very sharply. Also, we think the economy is contracting now. We are close to zero.”

A 1.25% rate cut in December would take the cash rate to 4%.

The cash rate was at 4.25% in late 2001 and has not been below that level since the RBA began publishing its cash rate target in 1990.

Economists point out that the debt futures market is signalling a cash rate low of around 3%, which would be the lowest level for rates since 1960, when the credit squeeze hit that year and

Federal Treasurer Wayne Swan still claims the budget won’t go into deficit: the forecasts reckon it will, and they were supported by the latest update from the well-connected Access Economics team in Canberra.(Source).

Goldman Sachs JBWere’s downgrade follows one in the US from their economics group there for the US on Friday:

Goldman Sachs said US GDP was shrinking at a 5 % annual rate in the current quarter and will drop 3% and 1% in the next two quarters.

It said in a note US unemployment will reach 9% by this time next year. In contrast the US Fed reckons unemployment will get to 7.6% next year (it’s 6.5% at the moment).

This morning in a note to clients sent out over the weekend, Goldman Sachs JBWere said:

“We have revised down our economic growth forecasts from 2.0% in 2008 and 1.7% in 2009, to 1.8% in 2008 and 1.0% in 2009.

The new forecasts incorporate a deeper recession through 2H08 than we first forecast in early October and a shallower recovery path through 2H09.

“We have also revised our interest rate forecasts, with the RBA now expected to cut the cash rate to 3.5% by March 2009 (75bp lower than our previous forecast).

“The combination of dramatic financial wealth destruction, debilitating tightness in money markets, rapidly slowing credit growth, sharp falls in commodity prices and evidence that Australian house prices are declining led us to formally adopt a recession in Australia as our base line view on 12th October.

“Since that time our conviction that Australia is poised for its first recession in 17 years has strengthened.

“The reduction in commodity prices by our resource strategy team suggests that Australia’s terms of trade will decline ~20% year on year by end- 2009, sufficient to strip around 3.0% from domestic demand growth.

“We now expect business investment to decline 7.0% in 2009 (was -1.7%) and domestic demand growth of just 0.6% in 2009 (was 1.8%). As such, we have also raised our estimate of the unemployment rate from 6.5% by end-2009 to 7.5%.

“We believe economic growth will contract -0.5% in the September quarter, -0.3% in the December quarter and -0.1% in the March quarter.

“This would be sufficient to see GDP decline -0.6%yoy in the March quarter 2009 and -0.3%yoy in the June quarter 2009 before an acceleration to +3.25%yoy by December 2009 as the combined effects of the interest rate cuts, A$ weakness and fiscal stimulus coagulate in 2H09 and drive a rebound in demand.

“We remain convinced that the Australian economy faces a debt-deflation cycle. The risk of deflation was brought home to all policymakers by the sharp fall in US inflation in October.

“In essence, we believe the threat of deflation (no matter how small) will accelerate plans of interest rate cuts and we now expect the RBA to cut interest rates 100bp in December, 50bp at its next meeting in February and a further 25bp in March.
“This will take the RBA cash rate to 3.5% by March 2009, a 375bp cutting cycle since September 2008.

“We believe the government should worry less about protecting an underlying surplus and more about providing the conditions to promote aggregate demand growth.

“We have downgraded our Market Forecasts reflecting a reality check due to the current market turmoil as well as incorporating the recent revisions to our commodity forecasts and domestic economic growth forecasts.

“Reduced our Industrial top-down FY09 EPS forecast from -5.0% to -15.0% (bottom-up forecast is +3.3%). – Reduced our resources FY09 EPS growth forecast from 0.0% to -15.0% (bottom-up +4.4%) and our FY10 from +15% to -5.0% (bottom-up +20%).

“Our revised forecasts for the ASX200 are: Dec’08: 3400 (previously 4525; -25%) – Jun’09: 3780 (4975; -24%) – Dec’09: 4100 (5350; -23%). The ASX closed at 3374 yesterday , so it’s already under the 2008 forecast of GSJBW.”

Merrill Lynch wrote yesterday:
The Australian economy is being overwhelmed by the global financial crisis and external growth shock, impaired credit markets, collapsing asset prices, and imbalances on the household sector balance sheet.

We are downgrading our 2009 GDP forecast to 0.2% (down from 1.7% previously).

We expect the economy to contract on a through the year basis over FY09.

In our view, the very substantial monetary and fiscal policy response and adjustment in the exchange rate will not be sufficient to avoid a recession over 1H2009.

Our business cycle analysis and leading indicator frameworks are pointing to a rapid deceleration in domestic demand growth over the next 3-4 quarters.

Lead indicators of employment (and income growth) have deteriorated significantly over the past quarter.

Our downgrade to GDP growth covers all components of private demand (household spending, housing and business investment) and export volumes.

Business investment in particular will be negatively impacted by the global recession, the fall in the terms of trade and the tightening in the supply of credit.

Global lead indictors have fallen deep into hard landing territory. ML is forecasting global growth of just 1.5% in 2009, down from 3.4% in 2008.

The commodity price and terms of trade decline in 2009 will sharply reduce gross domestic incomes (both directly and indirectly).

The steep decline in asset prices over the past 12 months and need for households to lift savings and de-lever reinforces a very weak outlook for household spending through 2009, despite the cash-flow relief coming from lower interest rates and petrol prices.

We expect the labour market to weaken significantly over the next 12-18 months with employment growth falling to -2.0% by late 2009 and the unemployment rate rising to 7.5%.

The household savings rate is assumed to rise to 3.75% (from 0.9% currently) as de-leveraging intensifies.

We are more optimistic about 2010, with substantial global and domestic policy stimulus expected to support a recovery in growth. We expect GDP growth of 2.2% in 2010, led initially by a cyclical recovery in housing activity and strengthening global growth.

We expect the RBA to lower the cash rate to 3.5% by Q1 2009 in response to the global downturn, the deep slump in domestic demand growth and reduced inflation pressures.

The main focus of policy over the next 6-9 months will be addressing falling corporate and household income growth, which run the risk of exacerbating the de-leveraging underway in the economy.

And on Friday:

Citigroup’s global economic team issued its weekly update with these gloomy forecasts:
Financial conditions in the United States continue to deteriorate, increasing downside risks.

Collapsing US bond yields reveal considerable scope and need for fiscal action. Fed officials seem poised for further aggressive steps.

With a deepening recession in the euro area, and inflation likely to undershoot the ECB’s target, we expect the ECB to lower rates to 1% by mid-2009.

The Japan economy is likely to contract further, and we expect the BoJ to lower rates again.

The UK economy faces a long, deep contraction. But substantial policy action should eventually generate a recovery.

Question about economy

How have the fundamentals of the economy improved since the presidential election?
During the presidential campaign, Obama said McCain was out of touch for saying the fundamentals of the economy were strong.

When Obama was pushing the spending program he said the economy was in bad shape and would fail if we didn't pass the bill. Now he says the economy isn't as bad as some people say and the fundamentals of the economy are strong.

Is he saying that the fundamentals of the economy have improved because he passed the bill or is there something else I'm missing?