Global economy gaining traction, but risks remain

By Beata Caranci, Director of Economic Forecasting, TD Bank Financial Group

Consumers are more engaged, spurring improvements in the economy, markets and real estate.

The day has finally arrived when we can confidently say the global recession has ended. The world economy is gaining traction and is expected to expand at a rate of 3.8% in 2010. Behind the recovery lies a well-synchronized dance.

Financial markets are on the mend, as witnessed by sharp rebounds in global equity markets and declines in credit spreads. Housing markets are in repair, as seen in falling inventory levels and rising prices, particularly in the U.S. and the U.K. — the epicentres of the housing problem. Industrial production is on the rebound, as inventory levels are being replenished and global trade picks up. Last, and most important, consumers are more engaged, spurring improvements in the economy, markets and real estate.

A gradual recovery

The recovery is under way, but for the advanced economies that were deeply snared in the financial crisis, this recovery is not going to have the typical head of steam of past recoveries. For instance, the chart below demonstrates that the 1957-1958 U.S. recession reflected a contraction of similar magnitude to the 2008-2009 recession, but the pace of recovery then was more than twice as strong in the first year.

As a rule of thumb, growth in real economic output during the first year of a recovery is typically two to three times larger than the decline over the course of the recession. However, studies of past banking crises show that economic output grows more slowly relative to the pre-crises trend for a number of years after the recovery has taken hold. There are many reasons why this occurs, including large job losses, credit flow destruction, risk aversion among financial institutions and deep losses in household wealth.

Supporting factors

In addition to these broader, enduring influences, there are a number of key assumptions underlying our global recovery forecast. We anticipate ongoing but slow progress in the U.S. housing market. We also believe households will slowly rebuild their balance sheets and boost savings over time. In terms of monetary policy, central banks will need to carefully time their decisions to raise interest rates.

We are of the view that the road to recovery for the global financial system will not be free and clear of further pain, but ultimately additional disturbances will be absorbed within a global economy that has considerable economic slack. As an example, we anticipate that the U.S. commercial real estate market will contract throughout 2010 and likely place a number of small financial institutions in distress. However, the impact on larger financial institutions and the broader economy will be far more limited than the recent credit crisis.

Another of our assumptions is that governments will take credible actions to address soaring deficits and debt, but won’t act so dramatically as to kill off their domestic economies or the global recovery. And last, although the precise shape of future international financial regulation is uncertain — as is the timing and trickle-down impacts to the economy and financial system — we assume that financial regulators will aim for it to be neither too hot nor too cold.

Mindful of risks

It may look like a Goldilocks scenario all around, but it is important to be mindful of the many risks to this scenario. In terms of the upside risk, household spending could come back faster than we currently anticipate. Among the downside risks, additional financial shocks could be more harmful to the recovery and could be exacerbated by overly enthusiastic regulatory changes in the financial system. We also can’t dismiss the risk that governments around the world could act more aggressively on reining in deficits and debt, which could slow the recovery.

The fallout from the Great Recession will linger. The world economy appears to be on the right path, but many uncertainties remain, which will require analysts and investors to be fleet of foot to adjust to evolving circumstances and risks. It also warrants close monitoring of economic developments to assess the true path of the recovery.

In this issue		April 2010
	Global economy gaining traction, but risks remain		What’s in store for the Canadian housing market?
	What does the future hold for gold?		TD Waterhouse presents MoneyTalk and book review
	How to research market sectors in WebBroker		Our enhanced retirement site is designed for you
	Invest for principle and profit — the socially responsible way