Looking Ahead: The Global Economy in 2009

The Global Economy in 2009

Richard Urwin, Head of Asset Allocation & Economics in the BlackRock Multi-Asset Portfolio Strategies Team, assesses the prospects for the global economy in 2009

As 2008 draws to a close, corporate treasurers and CFOs may be forgiven for looking at 2009 with some trepidation. Financial markets still face extreme levels of volatility, the financial system remains under severe pressure and we continue to see leveraged investors being forced to sell assets. On the wider economic front, the secular market dislocation we have just witnessed has lead to a real dearth of credit for companies and a severe economic downturn. It is no exaggeration to say that demand collapsed during the third quarter of 2008. Some companies have reported unprecedented negative operating conditions. The sudden deterioration in a range of key economic indicators tells a similar story.

And the good news? Precious little, except that the inflation concerns evident in the middle of 2008 have now disappeared, although concerns over deflation – which have remained in abeyance for five years or so – have begun to re-emerge.

So will 2009 bring more of the same or are we getting closer to the point of maximum pain for the global financial system and the wider economy, albeit with a long healing process ahead?

What are the conditions necessary for a recovery?

At this stage, it is unclear when a trough may be reached. The most likely outturn, however, is that growth will weaken until about the middle of next year, followed by an extended period of sluggish growth. However, this course of events is far from inevitable and much depends on the extent to which the factors generating the downturn are reversed. So what needs to happen for a ‘benign’ recessionary outcome - not too long and not too deep – to materialise? In practice, four conditions are necessary to facilitate this scenario:

• A substantial easing in interest rates;

• A supportive fiscal policy;

• A sustained fall in the prices of the major commodities;

• A significant improvement in money market liquidity in the form of lower spreads and a reduction in the role of central bank intermediation.

While the first three conditions are highly likely to be met, the prevailing illiquidity in a number of key capital markets, means that significant progress needs to be made in this area for a cyclical trough to be reached at some stage next year. [[[PAGE]]]

What are the constraints on a full recovery?

Three further conditions need to be met to generate a strong recovery from any trough:

• Housing markets in the US, UK, antipodean and fringe European economies have to stabilise in terms of prices, activity and defaults. This bottoming process may well extend into 2010;

• The global banking sector and capital markets have to finance private sector credit demand. Even without limiting the provision of financing through material credit rationing, only single digit expansion is likely going forward; and

• Consumer and corporate sectors do not attempt to deleverage significantly. However, this is not a given particularly in light of the significant consumer debt in the US and other ‘anglo-saxon’ economies.

The next quarter or two are likely to see a continuing loss in macro momentum, with corporate and ecomonic news flow remaining challenging.

In summary, the next quarter or two are likely to see a continuing loss in macro momentum, with corporate and economic news flow remaining challenging. This difficult growth background is expected to eliminate for some time concerns over inflation – although concerns over widespread deflation are exaggerated - and cause policy in the developed and emerging world to continue to be eased significantly. We expect the economic decline to bottom out at some stage in 2009 followed by a shallow rather than particularly vigorous recovery, with a fully-fledged ‘self-sustaining’ recovery not looking likely before 2010/2011.

What are the implications for corporate treasurers and CFO?

The financial crisis and ensuing global recession is throwing up a host of challenges for treasurers and finance directors. From an investment manager’s perspective, two challenges in particular stand out: the renewed funding pressures faced by corporate pension schemes and cash management. These are two crucial topics that deserve a more detailed analysis than we can accommodate within the space of this article. However, suffice to say that in both instances, a lack of in-house expertise and resources is increasing interest in outsourcing to specialists who provide a one-stop shop approach. In the case of pension schemes, this is likely to involve a wider adoption of the fiduciary management model already prevalent in the Netherlands, while in the case of cash management, this is translating into a greater use of stable NAV money market funds that offer the level of credit analysis and risk management required to navigate these turbulent markets.