Is the RBA missing a world recession?

Founder and Publisher of the Switzer Report
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As Tuesday’s Reserve Bank board meeting looms, what happens over the next few trading days should determine whether we get an interest rate cut or not. And the RBA’s research and understanding of the world economy will be tested, with many of the Bank’s assumptions about the future health of our economy being reevaluated to the downside.

In case you missed it, Wall Street was initially up more than 120 points overnight, but stocks dived in late trade with the Dow closing down 179 points, or 1.61%, at 11,010. The key drivers of this were concerns that the Shanghai Composite index had hit a new low for the year and that copper prices had tanked 8% on the day. Copper’s price is often a good indicator of the direction of the global economy because copper is so widely used in manufacturing.

Meanwhile, CNBC posed the question on whether the world is heading for a synchronised recession. Now the International Monetary Fund (IMF) doesn’t think so because they’ve recently forecast global growth of 4% for 2011 and 2012. But advanced economies are expected to only grow by 1.6% this year and given the IMF’s ordinary track record on forecasting in recent years, this is not a long margin for error and recession.

However, the 4% figure is for the whole world, which is being carried by Asia and I don’t see this lot falling in a black hole as some alarmists would argue.

The CNBC article said some US experts were talking to their clients about a global recession, pointing to a client note sent out this week by Morgan Stanley’s Adam Parker, the head of US equity strategy.

“A more sinister scenario could also unfold, namely a global synchronous recession where deflation becomes more visible,” Parker said. “In recent days, a number of clients have told us they are having great difficulty in getting defensive, even when they want to.”

But please don’t get too negative yet because Parker only rates this scary scenario as a 10% chance. I don’t buy the China-will-fall-over argument and neither does Christopher Wright, the retiring Senior Trade Commissioner for Austrade in Shanghai (he’s about to move to a senior position with a Swedish mining company in China — Sandvik). Wright is a big believer in China’s growth potential. You can watch my interview with him on our website and I think you should check it out.

That said, the RBA can’t ignore the weak outlook for the advanced economies and that will inevitably hurt their bullish forecasts on the terms of trade and imminent business investment.

Parker’s worst-case scenario says US company earnings would fall by 30% and while this sounds terrible, remember that they fell by 50% in the 2001 and 2008 recessions!

Undoubtedly, the European bailout news in coming weeks and the progress of US economic data will determine the fate of advanced economies and whether they fall into recession. And that’s why it would only be plain pigheadedness that would stop the RBA from cutting rates on Tuesday. A rate cut would help a lot of local industrial stocks that have been beaten up because of the high dollar, high interest rates and a subdued consumer as well as business spender.

Tuesday is a big test for the Reserve Bank’s million dollar man – Glenn Stevens – and I hope he’s a good enough economic analyst as well as a big enough man to admit that it’s time to look at the new facts and change his position on interest rates.

The job of stopping this “global synchronous recession” falls (some would say unfortunately) on the hands of policymakers around the world. Germany’s parliament must come to an agreement with the French government and Greece’s parliament over the EU’s debt mismanagement; China must orchestrate a ‘soft landing’ in their economy; and in the US, Congress must cut the deficit while still fostering growth.

“The longer the sovereign crisis goes on without resolution or empty ‘we are having constructive talks’ type statements, the more the market believes that there are very large entities within the European financial sector that cannot take any type of Greek default or haircut,” said Alec Levine, a derivatives strategist with Newedge Group. “Time is not on the side of the policymakers.”

Let’s hope they act fast.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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