There is no doubt that the deflationary forces unleashed by the credit crunch continue to be felt. Reports on bank lending standards show a chastened sector that is scrambling to shut the stable door now that the horse has bolted. Fortunately, much of the corporate sector is in good health, with only a limited need for external finances. Exceptions are not too hard to find, however, with private equity-owned and commercial property companies being more vulnerable.
The central banks will look on with mixed emotions. Relief that risk is being properly priced again will be counter-balanced by an appreciation that banks need to rebuild their capital reserves after making big write-offs in 2007. They will also be acutely aware that the last thing banks need is another round of defaults following their travails last year. Fortunately, it is within their power to help. We expect that they will continue to lower interest rates to ease cashflow pressures on existing borrowers and do everything in their power to steepen yield curves to allow banks to make low-risk money and rebuild capital.
The reaction of Main Street to events on Wall Street may well define the nature of the slowdown. There is no doubt that companies are becoming more cautious but we question whether business leaders’ worries are resulting in dramatic actions. Guidance for first quarter earnings is being trimmed, not slashed, and in our opinion the jury is still out on whether business confidence is imploding.
Who will replace Americans as the consumer of last resort will take time to answer. It could be that changes in macro-economic settings for either Europe or Asia will signal who is in the process of taking up the running from the US. The International Monetary Fund has indicated that it would like to see a fiscal stimulus in Europe. Currency revaluation in China would leave scope for interest rate cuts and domestic reflation. Ultimately, either or both of these changes probably need to happen to get the world back on an even keel and looking forward to sustained new growth. In the meantime, the US is once again buying itself and everyone else some breathing space by stimulating its economy.
Bill McQuaker and Katy Gladstone are heads of multi-manager at Henderson Global Investors