Morgan Stanley: Be Prepared for Dual U.S./Japan Recession

Japan could find itself facing a recession, hand-in-hand with the U.S.economy, wrote Takehiro Sato in Morgan Stanley's Global Economic Forum.

Noting that recent debate over the coupling/decoupling of the leading and emerging market economies has led to widespread acceptance of the "recoupling" view, Sato believes that "the argument that Japan’s economic performance is still decoupling from the U.S. is unconvincing." The following is an excerpt from the Global Economic Forum:

METI forecasts indicate that industrial production is likely to drop in the Jan-Mar quarter. Cuts led by the steel, non-ferrous metals, electrical machinery and transport equipment sectors are poised to reduce output from the manufacturing sector overall in successive months, by 0.4% MoM in January and 2.2% MoM in February. Even a flat March would leave production for the quarter down 1.5% sequentially for the first drop in four quarters. IT-related industries such as electronic components and devices are planning to curtail output in January and February after increases in December. Over-extended production forecasts for general machinery (+4.4% MoM in January) and IT/telecom equipment (+12.8%) also suggests that plans may not be met...

The signs of a recession in Japan are still incipient, so it is probably too early to start talking about the timing of the recovery. If the U.S. stimulus package bails out Japan by allowing industrial output to pick up in Jul-Sep, the domestic recession like that in the U.S. would fizzle out in just two quarters. In that event, it might not even earn the official designation of a ‘recession’, and instead be characterized as a ‘soft patch’ like the hiccups in early 2003 and the second half of 2004. Whether we do get a full-blown recession probably depends more on trends in the U.S. economy than on domestic factors, and especially on whether U.S. housing prices crash as commercial banks and the household sector are slammed with balance sheet adjustments on the scale seen in Japan. If there is balance sheet deflation in the U.S., there is no guarantee that the recession there would end with two mild quarters of negative growth. Besides which, what happens in China may have a lot more impact than is currently recognized.