October 08, 2008
The IMF's Outlook
The world economy is now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s. Against an exceptionally uncertain background, global growth projections for 2009 have been marked down to 3 percent, the slowest pace since 2002, and the outlook is subject to considerable downside risks. The major advanced economies are already in or close to recession, and, although a recovery is projected to take hold progressively in 2009, the pickup is likely to be unusually gradual, held back by continued financial market deleveraging. In this context, elevated rates of headline inflation should recede quickly, provided oil prices stay at or below current levels. The emerging and developing economies are also slowing, in many cases to rates well below trend, although some still face significant inflation pressure even with more stable commodity prices. The immediate policy challenge is to stabilize global financial markets, while nursing economies through a global downturn and keeping inflation under control. Over a longer horizon, policymakers will be looking to rebuild firm underpinnings for financial intermediation and will be considering how to reduce procyclical tendencies in the global economy and strengthen supplydemand responses in commodity markets.
Here is an excerpt from Table 1.1.
Table 1.1 from Chapter 1 of the IMF World Economic Outlook (October 2008).
Working off the 2008 q4/q4 growth rate, it appears the Fund is projecting an annualized -0.43% growth in 2008H2 for the US. These projections were based on data up through mid-September. Commenting on the implications of recent financial turmoil, the report continues:
...A worrying aspect of this latest bout of turbulence is that there are now increasing signs that market strains are starting to fall more heavily on the nonfinancial corporate sector and on emerging markets. If sustained, such strains could well foreshadow a more severe macroeconomic impact of the financial crisis than previously anticipated.
The nonfinancial sector in advanced economies is now more broadly affected than during the earlier stages of the crisis. Spreads on highgrade nonfinancial corporate bonds, which have risen gradually since the beginning of the crisis, rose further during the latest round of turbulence (first figure). They now stand at almost double the 2002 peaks and indicate a default risk comparable to that of emerging market sovereign debt. Low-grade corporate spreads also surged, but they remain below the historical highs of 2002. Access to short-term financing has tightened and equity prices have declined (upper panel of second figure), although equity prices still remain above previous troughs.
The recent surge in borrowing costs for nonfinancial firms has taken place against the backdrop of a gradual worsening of their risk profiles over the course of the financial crisis. The market-based measures of default risk and leverage ratios have risen across the credit spectrum in both the United States and Europe -- not only for low-grade bonds, as would be expected during a slowdown, but for high-grade bonds too (middle panel of second figure). For high-grade corporate bonds in the United States, for example, the probability of default has doubled since June 2007, although it remains below the levels experienced in 2004, in part owing to strong corporate balance sheets, particularly, ample internal funds.
Why are high-grade nonfinancial firms being affected more severely during the current crisis than during the previous major decline in financial markets in 2000-02, following the collapse of the dot-com bubble? A possible general explanation relates to differences between the shocks that triggered the respective downturns. The current downturn has its roots in the financial sector, where the originate-to-distribute model largely ceased to function. The financial shock is being transmitted to the nonfinancial sector via tighter financing conditions and, more recently, a drying up of market liquidity. The ubiquity of these channels leaves little room for differentiation across the credit spectrum. In contrast, the dot-com bubble originated in the nonfinancial sector, notably high-yield corporate credit, and was transmitted mainly through the solvency channel, affecting low-grade nonfinancial corporate bonds to an appreciably larger extent than high-grade ones. A more specific reason for increased pressures on high-grade nonfinancial firms relates to a growing concern about their rollover risk during the current crisis, because refinancing plans have led to a bunching of maturing bond obligations over the coming years, while bank financing has tightened. Moreover, declines in equity prices have increased the cost of raising capital. ...
In other words, we are all Wall Street now...
Against this macroeconomic backdrop (in addition to financial sector rationales), the coordinated interest rate drops of 50 bps makes a lot of sense.
The report is extensive and well worth reading, even if some of the data is dated due to the extraordinary pace of events. Also see the IMF's Global Financial Stability Report (Summary Report) .
Update 10/8 12:20pm Pacific: From Reuters, "Harvard's Feldstein Says U.S. Recession to Be Longer Than Usual".
Posted by Menzie Chinn at October 8, 2008 09:32 AMdigg this | reddit