US recovery likely to be L-shaped

HSBC says the bombings in the US may hit consumer spending and prolong that economic recovery.

Wednesday, September 12th 2001, 7:49PM

Fundamentals: There is a risk, probably high, that this crisis, as it unfolds, could come to precipitate the capitulation of the US consumer and mark a new inflection point in the US recession.

While the probability of an inter-meeting rate cut, perhaps in excess of 50bps, is high, nevertheless, a leg down in domestic demand must be considered likely as fear of the crisis' consequences drives increased savings, decreased spending, and reduced investment commitments.

Note collapsing-to-pressured equity markets both in the US and worldwide will likely deflate any vestiges of remaining wealth effect among consumers, while depressed earnings will limit real wages growth; both further depress any bias towards consumption, at least over the near term.

The impact on Asia will take time to materialize but will be nonetheless as material.

Beyond near term panic selling as markets open this morning, the realisation that the US landing will develop 'L-shaped' characteristics suggests yet another wave in downward revision to externally-generated growth dynamics, and ultimately GDP expectations.

Where recently, we have started to witness mixed economic signals among domestic economies; the risk is now that these green shoots will die as (still weak) domestic demand drivers are left to shoulder the growth burden.

Inevitably, a slow growth environment could decelerate moves among regional governments to roll-out reform, which could have potentially far-reaching consequences in terms of foreign direct investment and ultimately, medium term capital formation.

In the event flight-to-quality behaviour 'breaks out' among safe-haven-conscious investors, credit could be additionally squeezed to industry, particularly among the small and medium sized business sector.

A possible inter-meeting rate cut and a weak US dollar suggest monetary policy around the Asian region can remain easy and supportive. While, obviously, generic risk premiums have to be raised, it is hard to imagine circumstances at the current juncture that would push up short-end rates to levels akin to 1997/98.

Higher oil prices could pressure the external accounts of the net oil importers (save Malaysia and Indonesia); yet stronger currencies versus the dollar should offset the impact.

Depending on culpability of the outrage, there is a risk that selected sanctions and/or military responses by the US could also impact either individual economies and/or the region at large.

Beyond the possibility that the outrage could have domestic origins, inevitably, targeted retaliation at certain countries/segments in the Middle East could elevate the price of oil for months, particularly so since US inventories are relatively low.

Indeed, safe haven stock building of all major commodities is likely out of fear of a possible US response.

Market risk: Near term, expect to see equity market opening limit down with worse hit sectors including: re/insurance, air carriers, transport, and possibly oil/gas dependent utilities. Medium term, expect a gradual pricing in of the implications on Asia of hard landing in the US.

This will most visibly impact the electronic-heavy economies of Singapore, Taiwan, and Korea. We believe the impact on Malaysia will be partially offset by its oil and broader commodity bias.

In the Asian fixed income markets, we would expect sketchy liquidity to be directed at safe haven names (China, Hong Kong, possibly AAA-rated Singaporean names), oil producers, commodity-heavy producers, etc.

One possible ramification would see an unwinding of Korean USD assets held by Korean onshore investors, as the stronger KRW (a function of stronger JPY) and weaker dollar forces a switch.

Clearly, a long Malaysia position would benefit, particularly as its oil/commodity upside is re-priced.

This article was written by HSBC.

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