Not so fast
Jun 18th 2009
From The Economist print edition
Appetite for risk may have returned, but the crisis is not over
Illustration by S. Kambayashi
Low interest rates are intended to ease the burden on debtors, discourage saving, encourage spending and thereby revive the economy.But they also have a distorting effect on asset markets. By reducing the cost of speculation, they encourage bubbles.
So although it is good news that some indicators (such as the cost of bank borrowing) have improved, risk appetites also need monitoring closely. The “search for yield” which marked the boom of 2005, 2006 and early 2007 seems to have started again. Retail investors, disappointed with measly returns on savings accounts, are piling into corporate-bond funds. One British manager is reportedly raking in £1 billion ($1.6 billion)a month.
Those investors will have to hope that the managers choose their bonds wisely. Standard & Poor’s, a credit-rating agency, reports that more companies have defaulted in 2009 than in the whole of last year, and expects the default rate, 7.29% in May, to hit 14.3% by next year. The agency’s “weakest link” category contains 290 firms, with nearly $370 billion of debt, that are deemed to be at risk of failure.
The banks are also rediscovering their willingness to take risks. In a review of the investment-banking sector on June 15th, JPMorgan said that rival banks, eager to rebuild market share, are offering to do deals at “irresponsible prices”.
The silver lining to this cloud is that large companies have been able to take advantage of investor enthusiasm to raise money in both the bond and equity markets. J. Sainsbury, a British supermarket group, launched a £445m rights issue on June 17th to fund expansion plans. The very idea would have been unimaginable three months ago.
All this is encouraging the feeling that the worst of the crisis is over. Equity markets enjoyed an almost uninterrupted rebound between March and mid-June; according to Société Générale, the MSCI World index rose in 13 out of the 14 weeks to June 12th, the best sequence since December 1999. This, in turn, was linked to the feeling that the worst of the recession was seen in the first quarter, and that the global economy could be rebounding by the second half of this year.
There is a kind of positive feedback loop here, in which confidence about the economy boosts the stockmarket and a rising market helps restore economic sentiment (indeed, share prices are included in leading indicators). As strategists at Citigroup remark, the world seems to have moved from worrying about the Great Depression to talking about the Great Escape.
But how real is this shift? Not all the recent economic data have been positive. The June Empire State survey of manufacturing activity in New York showed a retreat. German export figures for April showed a 4.8% month-on-month fall. The latest figures for American and euro-zone industrial production showed similar dips. American raw domestic steel production is down 47% year on year; railway traffic in May was almost a quarter below its level of a year earlier. Bankers say that chief executives seem a lot less confident about the existence of “green shoots” than markets are.
The danger is that policymakers have done more to revive the financial markets than they have to shore up the real economy. Tim Lee of pi Economics thinks the authorities are simply inflating another bubble. The carry trade (borrowing in low-yielding currencies to invest in higher-yielding ones) has returned, as shown by the strength of the Australian dollar.
This bubble may start to deflate. Investors are already rediscovering their appetite for government bonds: the yield on ten-year Treasuries had drifted back from a peak of 3.93% on June 10th to 3.67% a week later. Investors may be starting to realise that, even if the biggest falls in output have passed, the outlook for 2010 is still likely to be sluggish.
After all, the problems that existed at the start of this crisis have not gone away. Delinquencies on American mortgage loans are still rising: the seasonally adjusted rate in the first quarter was higher across all categories. European banks may still need to write down another $283 billion of assets this year and next, according to the European Central Bank. Worst of all, Capital Economics says American consumer debt is more than 130% of disposable income, double its level in the 1980s. Reducing this ratio will require widespread defaults, rapid inflation or a prolonged period of higher savings rates. None of those would be particularly good news for the markets. The crisis took a long time to build up.It will not disappear as a result of one good quarter.
Copyright © 2009 The Economist Newspaper and The Economist Group. All rights reserved.
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