North American & International Economic Highlights
by Benjamin Tal
Things have changed very quickly in the past three months. In March of this year the stock market thinking was dominated by despair. Earnings were in a clear downward trajectory, the US financial system was in disarray—with rising concerns about Alt A mortgages, commercial real-estate and credit cards losses, the TED spread was hovering around 100 basis points, the auto sector was begging for bailout money, the housing market did not show any signs of bottoming out and consumer and business confidence were at record lows. And yet, this environment has generated a 40% breakout in the stock market that caught almost everybody by surprise.
Of course, during the course of this rally there was no shortage of commentary dismissing the swing in stock prices as insignificant, short-lived or a bear market rally. Those gloom merchants missed not only the big picture, but also the strongest pre-recession-end stock market rally in the post war era.
But the stock market was not the only surprise. As recently as March the commodity market was viewed by many as a dead market. The CRB is now up 28% from its recent bottom, and oil prices at $70 are a full $35 above their long term average—not bad considering that we are still in the midst of one of the worst recessions since 1945.
The bond market has been also busy during this remarkable second quarter of the year. Despite heroic affords by the Fed to put a cap on the long end of the curve, the 10- year rate is now 1.27% higher than its level in mid-March, with the 3-month to 10-year yield curve steepening by roughly 150 bps. As illustrated in the chart, a steepening in the yield curve is basically a precondition for an economic recovery.
Yes, there are many reasons to believe that things are a bit different now. The stock market is probably ahead of itself, while the yield curve is too steep for the current stage of the economic cycle. All indicators and common sense suggest that this recovery will be muted. After all, the US housing market is yet to find its footing, consumers are in a bad mood and deleveraging is king. Savings, not consumption, will be the new “in”. Add to this mix a new wave of regulation, protectionism, higher energy prices and more expensive borrowing costs, not to mention potential fiscal tightening, and you have a recipe for a sub par recovery.
But the signals from stocks, commodities and bond markets suggest that while the next several quarters will be lacklustre, the medium-term outlook could be brighter than many currently suspect. Just a thought
Benjamin Tal
Senior Economist
Economics