Brace for slow recovery

If there was any doubt that North America is in a recession, it has been laid to rest by five of Canada’s top economists, speaking at the Economic Club of Toronto on Monday. The only question that remains is How bad will this be?

“Trying to do an economic forecast in this kind of turmoil is a bit like trying to put a value on your house when the kitchen is on fire,” said Douglas Porter, deputy chief economist, BMO Capital Markets. “You just don’t know how long the fire is going to go on for, or how much damage it is ultimately going to do. It’s safe to say that the longer it goes on, the more serious the damage is going to be.”

He says the most recent sell-off on the stock markets has reflected much more than just weakness in the financial sector. It was a “classic cyclical sell-off,” with resources, industrials, technology and consumer discretionary stocks all falling by double digits.

“It’s almost as if the equity markets were bracing for a very serious downturn,” he said.

That sentiment was echoed by Warren Jestin, chief economist, Scotiabank.

“By the end of next summer, I expect we will have had little, if any, growth in Canada or the U.S., and a period of very soft economic growth in Europe as well,” he said. “We believe that by the time we get into late winter, both the Bank of Canada and the United States Fed will have lowered interest rates 100 basis points, with Europe following, but by perhaps not as much.”

“Our view is that it will be a shallow recession,” said Craig Wright, chief economist, RBC Financial Group. “The bad news in that is that it will be a shallow recovery. We’re not going to see any sharp snap-back in growth because there’s not one sector of the U.S. economy that is positioned to lead us out of this weak spot.”

Far from being insulated from the slowdown, Canada will see its exports to the south fizzle. The rest of the world is already following the U.S. into recession.

“I think the decoupling story has been destroyed,” said Wright. “Globalization means the exact opposite of that, and we’re seeing that, especially in the financial world, the U.S. is the proverbial tail that wags the dog.”

Drummond expects “little or no growth” in the developed economies until late 2009, with no snap-back in 2010.

“Anytime the U.S. has had an extended period of weakness, it has tended to come roaring back, with four, five, six per cent annualized rates for a while,” Drummond said. “But I think the credit system is going to be mucked up for some time. Even as we get into 2010, we’ll be just creeping back to more of a normal growth rate, instead of that strong spring-back.”

Wright is watching the TED spread — the difference between interest rates on inter-bank loans and short-term U.S. T-bills — as a signal for any improvement in the credit markets, which lay at the heart of the recession.

In the past, a normal spread would be about 30 basis points, but recently that has ballooned to over 350. Don’t expect a return to the good old days, though. Wright says the “new normal” for TED spreads is likely to be about 70 to 80 basis points.

“We’ve been at the pessimistic end of the forecasts for quite some time, and it seems to be getting a crowded field,” said Don Drummond, chief economist, TD Bank Financial Group. “Until [bank credit spreads] get down substantially, we’re not going to get the economies moving.”

As for the U.S. housing market, Drummond says it still has room to fall before potential homebuyers might be persuaded to make a deal. Another 10% to 15% drop would be reasonable, he suggested, which would take prices back to 2002 levels.

“As much as they’ve fallen, if you look at average housing affordability in the U.S., the percentage of income required to buy a house is still slightly above its long-term average,” he said.

In Canada, he says, housing prices may still fall from their current levels, but the market is very different from that of the U.S.

Cities that saw rapid rises in home values will be hardest hit. This will be especially true in Western markets, according to Porter, where falling commodity prices may lead to job losses in the extraction industries.

Avery Shenfeld, senior economist, CIBC World Markets, pointed out that there could be an upside for some. While homeowners are watching their net worth eroding, younger people who were frozen out of the market by skyrocketing prices may soon find an entry point.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(10/06/08)