In the Chinese calendar, it is the year of the Ox. Unfortunately, in the labour market it will be the year of the axe.
New Zealand may shed 50,000 jobs in the first half of the year, keeping consumers reticent to spend and the economy in recession. 2009 is shaping up as very dodgy and uncertain.
New Zealand spent most of 2008 in mild recession. Fortunately, the drivers of last year’s downturn – sky-high interest rates and petrol prices, drought, and the housing correction – are mostly behind us.
In fact, the cash flows of households with a job are much improved on mid-last year. Wage settlements are averaging close to 5%, interest rates are plummeting, petrol prices have fallen 40% from their peak, and the first round of tax cuts have been delivered.
Unfortunately, New Zealand is now faced with a different set of challenges, a severe international downturn and difficult access to credit. We fear that New Zealand will fall into a ‘new’ recession in the first half of 2009.
International woes
Full blown recession is occurring in all the Group of Seven leading industrialized countries. Also, the developing economies will, at best, be growing at half pace. Global growth may be as sickly as 0% or worse in 2009. In the 2001 recession global growth dropped to 2.2%, in 1991 to 1.5%, and in 1982 to 0.9%.
International economic data has been awful. The US economy shed 2.6 million jobs through 2008, with almost two million of those coming in the last four months of the year. Already the unemployment rate has shot up to 7.2% (from a cycle low of 4.4%), the highest since January 1993. Job losses may still reach one million per month.
The pain is being spread far and wide. Capital surplus economies, with their export focus, have ended up being a leveraged play on global growth. Japan’s industrial output contracted by 16.6% and exports by 26.7% for year-on-year in November.
Taiwan’s exports fell 28% and its shipments to China were down by 45%. Korea’s exports have been similarly hit.
There has been a US$32,000bn decline in global stock market capitalisation since the peak in October 2007, although we struggle to comprehend just how much money that actually is!
The obvious questions are: how bad will it be and how long will it last? Unfortunately no one knows.
More questions than answers
It is hard to get a grasp on just how deep and how long this international recession will be, because the rules of the game have changed completely
- this is the first modern recession driven by declining asset prices and balance sheets, rather than inflation
- there has been nationalization of banks, mortgages, and insurance
- the US central bank (the Fed) is now making credit rather than monetary policy
- the US Government has taken control of the long end of the yield curve by committing to buy Treasuries.
Questions abound: how much will the quantitative easing of the Fed increase bank credit rather than just reserve assets? What will be the ultimate inflation consequences of the ballooning of the Fed balance sheet? When will the massive US Government stimulus packages gain traction?
How much redemption risk remains (forcing liquidation of securities)? Will some countries seek protectionist trade policies and competitive devaluations, exacerbating the crisis? How will the capital surplus countries encourage their consumers to reduce saving and spend?
What will be the regulatory response to the crisis (with their inevitable unintended consequences)? How much more capital are global banks to write off from rising consumer and business defaults and exposures to emerging markets? And, if companies fail en masse what will be the repercussions through the $30 trillion credit default swap market?
In the spirit of Donald Rumsfeld: the known knowns are improbably probable, the known unknowns are decidedly undecided, while the unknown unknowns are possibly impossible! In effect, the entire global framework has been flipped on its head making prognostications on the future no better than a crapshoot. But for what it’s worth, we’ll make some guesses.
The global economy slipped into recession in August 2008. The average recession (which is quite harsh) tends to last around ten months. A reasonable pick is that this one could be twice as bad and twice as long as the average. That would imply that the world economy spends 2009 in recession.
Markets are likely to spend the first half of the year with bouts of increased risk appetite giving way to despondency as economic activity data continues to print weak.
Historically, equity markets have turned about four months before the end of recession. That is, equity markets anticipate the economic recovery, but the recovery needs to be within spitting distance before a sustained rally in share prices occurs.
Back in New Zealand
Towards the end of last year there were some moot questions around the economic outlook. Would New Zealand consumers save or spend their improved cashflow? How severe would be the job correction in New Zealand and how bad would be the contagion to our Asian trading partners? All of these questions are being resolved adversely for the near term economic outlook. Households are saving, a third of firms are planning to reduce staff levels, and Asian exports are plummeting.
It is not surprising that New Zealanders are breaking their bad habits of the past 20 years and starting to save. There are powerful incentives forcing the change in behaviour, including the parlous starting point for household savings, the fact that New Zealand is one of the most indebted countries in a world that is shunning debt, and rising job insecurity. The excesses of New Zealand’s past needs to be unwound.
The job market is the lynchpin of how the year evolves. If significant job losses do not occur, New Zealand will come through 2009 reasonably well (with GDP being boosted by grass growth, new mining activity, full Southern-hydro lakes, increasing electricity sector value add, and big additional Government spend). That appears to be a forlorn hope.
New Zealand businesses are faced with significant profit squeeze, flat to negative sales for many, a rapidly deteriorating external environment (showing through in export receipts and tourism), restricted access to credit, and massive uncertainty. Firms will respond in the same way they did at the end of last year: defer investment and lay off staff.
The latest Quarterly Survey of Business Opinion, a reliable indicator of business activity, was nothing short of horrendous. Headline business confidence in seasonally adjusted terms was the lowest since at least 1970. A third of firms expected to reduce staff levels. Own activity expectations fell to -43%, the worst on record by an order of magnitude (easily beating the previous low of -21% set in 1982).
Other key activity indicators either neared (e.g. employment intentions, building intention, difficulty finding labour) or surpassed (e.g. profit expectations) the lows of the 1991 recession. Weaker domestic demand is being felt across a range of sectors.
The share of firms citing lack of sales as their main constraint to growth rose to 75%, the highest since Q2 1999. Encouragingly access to finance still hasn’t featured as a major constraint; 7% of firms cited this factor, little had changed from Q2.
Inflationary pressures are rapidly disappearing, in part due to falling fuel prices. A net 42% of firms reported higher costs in the last three months and 27% still expect further cost increases in the current quarter. However, only 9% were able to raise their prices last quarter (though 28% intended to raise them), and a net 3% expect to lower their prices this quarter.
As with last year, it is not a ‘one size fits all’ environment. Some will continue to do well but on average New Zealand will languish, with activity contracting for the full year.
New Zealand’s woeful international debt position limits the scope for the Government to borrow and spend in order to counter the effects of recession. So it’s just as well that the Reserve Bank have plenty of room – far more than any major central bank – to deliver relief on interest rates.
Fast disappearing inflation, and the rapid deterioration in international and domestic prospects, keeps the door wide open for further aggressive interest rate cuts. By the end of 2009, inflation may plunge toward 0.5%. And wages will follow. We expect the Official Cash Rate to trough at 2.5% and interest rates are likely to remain low for a long period. We also anticipate the currency to contribute more to the monetary easing (with the Kiwi falling to the mid 40′s).
However, with central banks around the world effectively cranking up the money printing presses, there is the potential for markedly higher global inflation in a few years time if the central banks are slow to remove the extra liquidity.
We suspect they will be – they will want confirmation that any increase in economic activity is sustained, wait to see if it results in inflation, and by then it will be too late.
But again, the situation is so fluid and shocks so frequent, forecasting is fraught.
Never let a crisis go to waste
An old adage is to never let a crisis go to waste and this one is a doozy. It is a time for firms to be proactive, get on top of costs, examine every aspect of the business, focus on debtors and liquidity, force through difficult decisions, and stay close to your bank!
