What Lies Ahead for Developed Markets and the U.S.

by Inya Ivkovic, MA

For the first time since the International Monetary Fund (IMF) started collecting data about global GDP in 1970, the global economy will have recorded a decline of 1.1% in 2009. This number reflects an almost unison contraction among the developed economies, as well as the significant slowdown among the emerging ones. Additionally, global growth is expected to remain sub-par during 2010, potentially picking up the pace only in 2011.

Apparently, green shoots of recovery have sprouted around the globe. Yet, the developed economies are still struggling under nearly impossible conditions, including battling the tailwinds of excessive bailouts, the head winds of declining exports, extremely tight credit conditions, declining business levels, nearly non-existent consumer confidence, and rising energy prices.

My biggest fear is inflation, as the ripple effects of excess money supply spread through the financial systems. Granted, inflation has slowed distinctly in 2009, as oil prices collapsed in the second half of 2008. But in the second half of 2009, energy prices appear to be picking up steam, which, if they run up by year-end, could reignite inflationary pressures, potentially making them quite severe.

As the financial and credit crises accelerated and as growth prospects seemed to be evaporating, G7 had no choice but to apply aggressive monetary loosening and drop interest rates to near-zero levels. In North America, interest rates more or less have nowhere to go. In Europe, there is still some room to move. Tools available going forward are mostly of an unconventional nature, quantitative easing, will likely be used some more, particularly in the U.S. Interest rates are not likely to stabilize until late 2010 in some developed regions and for others not until 2011.

The U.S. is now enduring the worst recession since WWII. The slowdown started in early 2006 when the housing market first turned. But it wasn’t until January 2008 that the recession really hit a homerun, when the labor market turned. Negative GDP showed up in the third quarter, when consumers threw in the towel.

As of late, there may be reasons for optimism. Despite the past few weeks of volatility in the stock markets, the green shoots are there, at least eliminating that awful feeling of free-falling into a bottomless pit. Consumer confidence has somewhat improved, as have housing starts and sales.

However, jobs are still being shed at a fast pace, inventories are still bursting at their seams, and there is no indication that industrial production has bottomed. As a result, the U.S. GDP will continue declining for the second quarter, and potentially even into the third quarter, before stabilizing in the fourth quarter, albeit still yielding sub-par performance. By the end of the year, the U.S. GDP will have declined by four percent peak-to-trough.