Investors get a first glimpse of the likely shape of the new global financial system shortly as finance chiefs prepare for a summit of world leaders fighting the worst world financial crisis in 80 years.
After more than two months of relentless selling cut a third off the value of world Stocks, central banks have launched an unprecedented round of interest rate cuts to help prevent economies from sliding deeper into recession.
Such drastic action, which has helped to lift stocks from the low trough, is prompting calls for governments to follow up central banks by delivering tax cuts and fiscal stimulus.
Finance ministers and central bank chiefs from the Group of 20 industrial and developing nations are likely to be tackling this as they prepare a summit of G20 government leaders in November at Washington. The finance chiefs will meet in the U.S. capital, following up talks held in Brazil.
The roadmap so far has been painted by central banks but not governments. The conversation may turn from money markets and banking to the real economy.
Central banks have provided monetary stimulus. As for fiscal stimulus, government needs to be careful. They need to spend efficiently.
The summit is expected to focus on identifying the underlying causes of the crisis, establish principles for reform and set up working groups to address specific issues.
The International Monetary Fund is planning to push the G20 nations for a quick fiscal expansion to help to lift the economy. British Prime Minister Gordon Brown has also called for fiscal action. Investors will also keep a close eye to see if U.S. President-elect Barack Obama’s picks for key economic jobs could stem the tide of bad news after market euphoria following his election victory quickly evaporated.
Gloom over the economy was so great that an unprecedented 1.5 percentage-point interest rate cut from the Bank of England and monetary policy easing in the euro zone and Switzerland last week did little to bolster risky assets.
Banks can do whatever they want with interest rates but if banks don’t lend and consumers are not spending, that seems to be the crux of the problem. The velocity of money is zero. One hundred times zero is still zero. You need the velocity of money and the willingness to spend starting again.
According to Goldman Sachs calculations, G10 economies outside Japan have delivered on average 190 basis points of peak-to-trough easing. Interest rate markets are discounting total average easing of just over 300 bps across the group.
This compares with average easing of 330 bps seen in 2001-2004, although Goldman expects the economic slowdown this time would be at least as severe as during the 2001-2004 cycle.
Reuters polls show analysts expect UK interest rates to drop to 2.0 percent by March from 3.0 percent now, and the euro zone cost of borrowing to fall to 3.0 percent next month from 3.25 percent.
In the case of the United States, interest rate markets are attaching a more than 1 in 2 chance that the benchmark borrowing cost will fall to 0.5 percent from 1.0 percent.
If this week’s corporate earnings including retailers Wal-Mart and Macy’s and European firms ING and Vodafone undershoot expectations, investors could price in even further easing from major economies.
A steady stream of weak economic data, reinforced by data showing U.S. employers cut payrolls by a shock 240,000 in October.
It is likely that Obama will move decisively to tackle the immediate economic issues with the most significant action to be taken in the near term being a material fiscal stimulus package, probably in excess of $200 billion.
The near-term corporate and economic environment ensures that markets’ initial euphoria will likely give way to a more sober assessment as Obama’s plans become viewed as a damage limitation exercise rather than a precursor to renewed economic vigor.