On 7 August 2007, the Federal Reserve might have been able to forestall a recession in the United States. That day, with credit markets seizing up, the US central bank could have signalled an intention to cut interest rates to prevent a financial crisis becoming an economic one. It did not. It said the next move in rates was still likely to be up.
At the time, the Fed (and, to be fair, most economists) thought that what happens in the US housing market stays in the housing market, and that rising defaults among low-income Americans would not trigger a major slowdown in the rest of the economy.
The next rate change was not up, and it is now at 3.5 per cent, compared with 5.25 per cent in the summer. But the Fed and its chairman, Ben Bernanke, have struggled to shake the impression that they are far behind the curve. Yesterday’s 75 basis point cut, a panicked response to the global stock market sell-off, was an attempt to shore up confidence of the financial markets but will take a while to feed through to the economy.
Can it work fast enough to avert a full-blown recession? “At this point the answer is no,” says John Silvia, the chief economist at Wachovia. “The Fed is responding to the lack of credit and to the risk avoidance in the financial system, which is what they learned over the weekend. The market is seeing the Fed getting responsive, and believing that it can get the economy moving in the second half of the year.”
Yesterday afternoon, President George Bush met with congressional leaders to prepare an economic rescue package that could put an $800 (£408) tax rebate in the pockets of cash-strapped consumers. There will be other measures, too, perhaps more money for the food stamps programme that many low-income families rely on. Business, too, could get tax breaks. At least 1 per cent of GDP – $150bn – will be pumped into the economy, if the remarkable political consensus holds, and it could be done “long before winter turns to spring”, Hank Paulson, the Treasury Secretary, predicted.
Even that was damned as “too little, too late” when it was first outlined by the President last week. His speech on Friday was the moment when the global equity market sell-off began.
Economists agree, though, that every little helps. “Quick stimulus measures have the potential to prevent the economy from slipping into a downward spiral in which weakening demand begets job losses which in turn weakens demand further and so on,” says Kevin Logan, the senior US economist at Dresdner Kleinwort. “However, the stimulus is unlikely to promote vigorous growth, since the underlying problems in the housing sector will persist.”
For most of the past two years, the extraordinary thing about US consumers has been how resilient they have been: $3-a-gallon petrol? No problem. Negative equity amid falling house prices and rising interest rates? Don’t panic. Food price inflation? Just one of those things. Nothing appeared to be able to stop the consumer spending.
Except that this began trickling away, and quite fast, in the last few months of last year. There were disappointing readings on retail sales in December and a very worrying statistic about the unemployment rate ticking up to 5 per cent that month, too, which promises that more people will be forced to tighten their belts. Low introductory interest rates on 1.8 million recent mortgages will expire in the next two years, as well, taking another big chunk out of household spending power.
Michael Dicks, the head of research at Barclays Wealth, cautions against predicting consumer armageddon. “Recent US data have certainly contained more bad news than good on unemployment, employment, retail sales and housing. But employment data is imprecise, and open to revision. The consensus view on retail sales has also frequently been proved wrong in the past. This is not to say that the US economy is in no worse shape than in December: it clearly is. But we must not get carried away and shift the odds of recession to ‘well over 50 per cent’ just because of a few, poor quality, ‘bad’ data.”
Nonetheless, with credit card arrears rising, prompting tougher terms for all consumer borrowing, the ability to spend our way out of any slowdown is clearly limited.
China is the world’s factory, its economy enjoying its own industrial revolution and powering global economic growth. Profits from emerging markets have buoyed US companies in the past few years, and – at least until the weekend – the consensus view had been that Chinese economic growth in particular would be enough to rescue the global economy even if some parts of the US did tip into recession. The decline in Asian markets over the weekend has prompted economists and market strategists to revisit that view – but it may be too early to change it entirely. “If there is a slowdown in demand from the West, that is going to affect growth,” admits Michael Gordon, the head of investment strategy at the fund manager Fidelity, “but there is no way we are talking about a recession in China. Indeed, with the Hong Kong and Chinese currencies pegged to the dollar, both are likely to have to cut interest rates in response to the Fed’s 75-point cut, and that has the potential to reignite everything again.”
Ultimately, the US will enter a recession this year if unemployment rises. As well as being crucial to the level of demand in the US economy, unemployment is the main measure used by the National Bureau of Economic Research, the country’s official arbiter of when a recession has arrived. Which means that it is the chief executives of corporate America, the men and women in charge of hiring and firing, who will ultimately push the US into recession, or steer us away.
Currently at 5 per cent, the unemployment rate has to tick to 6 per cent, probably, to indicate clearly recessionary conditions. Profitability remains high, as the earnings reporting season under way in the US is proving, at least outside of Wall Street, the mortgage market and the housebuilding industry, where jobs are obviously being cut. However, the budgets set for the coming year will be crucial. Simon Denham, the managing director of Capital Spreads, the London-based financial spread-betting firm, says it is difficult to be optimistic, since the hundreds of billions of dollars lost by Wall Street on mortgages in 2007 has led them to bring in their horns and become much more cautious on funding the corporate sector.
“Whether we were entering a recession or not, now seems to be a moot point as the collective destruction of wealth over the past few weeks will almost certainly proscribe new corporate spending and, to a certain extent, consumer demand,” Mr Denham said. “The falls of the markets are very likely to create the very environment that we were fearful of.”