Recovery Efforts Pay Off: Too Bad It Won't Last

At the end of last year it looked distinctly like the global financial system was on the verge of meltdown and that the global economy was about to implode.

The change in market sentiment since has been dramatic. Various banking sector bailouts, the pledge of as much as $2 trillion to support the US financial system, passage of the $819 billion stimulus plan by the US administration and G20 agreement pledging $1 trillion for the World Economy, were major events over the first half of the year which helped to turn sentiment around.

More rate cuts by many central banks and expansion of quantitative easing, with the Fed purchasing $300 billion in Treasuries, and the ECB unveiling a EUR 60 billion covered bond purchase plan, provided a further boost to recovery efforts. This was coupled with the passage of US bank stress tests which at least gave some transparency on the state of US banks’ balance sheets.

These efforts appear to be paying off as confidence has improved, data releases especially in Q2 09 have revealed a much smaller pace of deterioration, whilst some US banks felt confident enough to pay back TARP funds, marking a turning point for the US financial sector.

Markets reacted to all of this news positively once it became clear that a systemic crisis had been avoided; most US and European indices, with the notable exception of the Dow ended H1 2009 with positive returns. However, their gains were less impressive when compared to the strong gains in some emerging equity markets, with indices in China and India registering gains above 50% this year as recovery efforts in emerging markets echoed those in the G10, but with the advantage of far less severe banking sector problems.

Currency markets have also given up the high volatility seen at the start of the year as many currencies have now settled into well worn ranges. Measures of equity market volatility have also swung sharply over H1 2009, with the VIX index now less than half of its 20 January peak. Other measures of market stress have undergone significant improvement, with much of this taking place in Q2. For instance, the Libor-OIS spread dropped to its lowest level since the beginning of 2008 and after peaking at close to 450bps in October 2008, the Ted spread has now dropped to a level last seen in late 2007.

The change in market sentiment in the first half of the year has been truly dramatic but there is little chance of it continuing. The second half of the year is already shaping up to be much more of a bumpy ride as relief that that the world was not about to implode gives way to questions and concerns about the pace and magnitude of recovery in the months ahead.

Comments

[Larry House:]

Yes, you are properly cautious. I am becoming more convinced that systemic risk has not been removed. It may have been pushed further into the future, but at this point, we cannot declare all systemic risk dead. If I am right, and this becomes more obvious over time, the markets will not like it at all.

Jul 02 12:10 PM

[whidbey:]

Your guarded optimism is more than justified but it misses the long range implications of our actions today.

The spending of the administration must have some short run effects, financial and sentiment. But Act II now comes when the Hero must pay the fiddler for his largess. This is the tragedy when good intentions died at the hands of reality and all realize that the plan is flawed. In the final act the choices become clear: we must cut the recovery baby in two. The demands for debt payment force the choice(nothing left for current spending if we honor our debts): The Choice Default on debt or Inflate out of the debt. Either way the end is slow, painful and destroys the economy for generations. No good can come from just looking at the short run.

Jul 02 12:20 PM

[Dave Wrixon:]

So Obama has been able to fool the majority. Not surprising really, he already did it in November.

Jul 02 01:07 PM

[Esol Esek:]

yeah it's all obama's fault. He's been in office for six months, and he's more responsible than the previous thirty years of nonsense. Has nothing to do with the self-serving white country-club males that preceded him and still occupy Congress in yokel la-la land....this kind of suburban rural delusion/small-mindedness is what is the real problem for America going into the future, because its easier to get violent than to change your spots and see logic. Funny how the rural South is still America's biggest drag on political progress. Also funny though how it was northern urban Wall-Streeters who engineered this entire debacle. Either side of this coin is a loser. Both of these populations and their influence need to be shoved aside for this country to go forward any longer.

Dont blame the european socialists either. They've got health care and a safety net, unlike America, where families shatter and you die (also a highly inefficient strain on public resources). This was all the creation of me-first white frat-boy empire-saluting couch-soldier idiots, and their snickering puppet-masters, who couldn't stand any sort of regulation or reason because it interfered with their entitled arrogance and easy cash flow.

America's problem is not just economic, but mental and political. Despite a detonation as obvious as the Soviet Union's, the US capitalist empire si still trying to balance with a leg of its stool knocked out. And look at Russia if you think being taught a lesson results in sense - it doesnt - it just results in a clampdown by the elites, like in China. The comedown of America will continue til at least half of these rotting elements of the past are expunged.

Jul 03 01:11 PM