Green Shoots Or Yellow Weeds?

Author: Nouriel Roubini

Many commentators are suggesting that the recent data from the manufacturing, housing and labor markets indicate that the "green shoots" of an economic recovery are clearly visible. While there do seem to be some signs of improvement, in that the pace of contraction has slowed, the most recent data may still suggest that the global economic contraction is still in full swing with a very severe, deep and protracted U-shaped recession.

Although the outlook for global manufacturing and service sectors is still consistent with a significant fall in global gross domestic product, the pace of contraction began to slow toward the end of the first quarter of 2009, even in Europe and Japan, which have lagged the U.S. and China.

Globally, surveys suggest that the manufacturing outlook has improved from the freefall of the end of the fourth quarter of 2008 and early 2009. Some emerging economies like China may now be experiencing expansion based on government investment, but manufacturing in most advanced economies remains well in contraction territory. In part, inventory adjustment following the sharp destocking could contribute to a revival in demand, but a real increase in end-user demand needed for a sustainable fast-paced recovery could be far off.

Another necessary condition for a global recovery is a bottoming in not only the U.S. but also global housing markets. So far, in most markets, housing prices seem far from their bottom and the outstanding inventory continues to be very high.

Moreover, there is a risk that the increase in commodity prices might choke off a sustainable recovery if it weighs on industrial production and consumption. The recent increase in commodity prices, driven in part by an increase in Chinese demand for crude oil and other commodities, has contributed to an increase in the Baltic Dry shipping index. Yet, given the significant inventory in commodities like oil, prices might suffer renewed declines. Moreover, although trade finance is no longer quite as impaired as at the turn of the year, global trade continues to be quite weak, as evidenced by recent data from China, the U.S. and other countries.

Accompanied by the rally in stocks starting in March, the wide variety of central banks' liquidity facilities have finally started to show clear effects in the interbank lending and money markets. Stress indicators such as the three-month LIBOR-OIS spreads have narrowed significantly as well as the TED spread. The stock market rally extended also to the bond market, with spreads receding significantly and junk bonds outperforming all other asset classes in the month of April. Is the worst over, or have markets overextended themselves?

United States

Some green shoots emerged in the U.S. starting in January and February 2009, providing relief to rest of the world that the global engine of growth, the U.S. economy, might be on the path to recovery.

Government transfer payments, public sector wages and holiday discounts boosted personal disposable income, consumer spending and retail sales in January/February. However, spending and retail sales are set to drop again. Optimism about recovery and tax cuts via fiscal stimulus have boosted consumer sentiment recently. But the rise in consumer spending witnessed in the first quarter of 2009 might be unsustainable in the coming months amid hiring freezes (indicated by record high continued claims), slower compensation growth, stringent borrowing conditions, the fading impact of lower energy prices and the need to increase savings to de-leverage and offset wealth erosion.

Auto plant closures and the removal of temporary workers hired for the government census might cause another spike in jobless claims and job losses in spite of some optimism in the April data. The ISM manufacturing index shows that industrial production and imports are also contracting at a slower pace since January/February, as firms have been aggressively slashing inventories and conditions for trade finance have improved. But if sales continue to plunge, the currently high inventory levels will have to continue to fall sharply in the coming months, which will be a negative for U.S. trade partners.

Similarly, some stabilization in starts and a rise in construction spending starting February/March signal that the supply side of the housing sector might be close to a bottom, and will continue to move sideways for some time. The persistent high level of inventories though, implies that the adjustment in terms of home prices in the U.S. housing sector might continue until mid-2010, possibly at a somewhat slower pace.

Canada

With its fortunes tied to the U.S., which absorbs about 75% of its exports, Canada would seem a strange candidate for early green shoots, but there are some signs of improved sentiment.

Canada actually added jobs in April 2009--albeit all in self-employment--but a breather from the sharp declines experienced from November 2008 to March 2009. Moreover, the descent of the Canadian housing market also seems to have slowed, at least temporarily due to seasonal factors.

Canada's shift back from trade deficit to surplus in February and March, though, reflects a weak loonie's dampening effect on imports, rather than any revival of demand in Canada's exports.

The relative soundness of Canada's banks, which are still extending credit to households and businesses, does protect Canada from some of the woes facing other G7 economies, but a recovery could be far off.

Europe

Just as the European Commission, the IMF and the OECD revised down their 2009 forecasts to at least -4% after a dismal first-quarter performance, Eurozone economic indicators are starting to paint a brighter picture, starting in April.

In particular, German manufacturing orders rose again on a monthly basis, thus corroborating the recovery signaled by business sentiment indicators. Similarly, both manufacturing and services PMI indicators recorded an increase, although they are hovering firmly in contractionary territory.

The most upbeat indicator so far has come from the OECD's six-month leading indicator, signaling that both France and Italy might have reached a possible trough in the first quarter. Already commentators are speculating about the shape of the recovery, but important structural headwinds remain.

United Kingdom

In the U.K., more and more analysts have suggested that the housing sector is bottoming, despite the mixed signs shown by different pricing and lending measures. April Nationwide data showed that prices registered a month-over-month (m/m) decline of 0.4%, bringing the year-over-year (y/y) rate to -15%, even as Halifax housing prices fell by a bigger than expected 1.7% in April, returning the average house price to 2004 levels. The fall in housing prices was still the smallest monthly decline since December, though.

On the economic activity side, April CIPS/Markit manufacturing PMI rose to a reading of 42.9, up from 39.5 in March. The index has now recovered substantially from the record weakness of November to February but remains firmly in contraction territory. Moreover, the services PMI for March, a survey of businesses ranging from banks to restaurants, also increased. This increase, the fourth monthly rise, continues to reflect contraction, if a less steep one. Even though the survey is bringing a slowing pace of decline in new business and business expectations, companies are still shedding staff at the fastest rate since records began in 1996. Retail sales for February were also on the downside, while unemployment is at its highest rate since 1997.