The bad news is that US fourth quarter GDP was revised downward to show a dazzling 6.2% decline (annual rate). This was the sharpest decline since the 1982 recession. The good news is that this quarter is behind us. The main contributors to the revision were lower investment in inventories, lower exports, and weaker consumer spending on non-durable goods. From the data we have to date regarding the current quarter, it appears that real US GDP will fall by an additional 5% (annual rate). So this is as bad as it gets. In fact, we can make the point that while the US economy will remain in negative territory for the next 4-5 months, the rate at which it is declining is slowing. The 10-year US Treasury yield is just under 3%, up about a full percentage point from its December low. Back then, the 10-year yield plunged following the Fed’s announcement that it was exploring the idea of purchasing longer-term treasury securities. The recent increase in long-term rates was largely due to increased supply and a daunting federal budget deficit which will clearly be dealt with by the Fed. Rising treasury yields are complicating matters for the Federal Reserves; since higher long-term rates restrict growth. At this stage of the game, the Fed will probably look into buying these securities in order to lock-in the improvement in long-term
mortgage rates.
The issue of a de facto nationalism of American banks is clearly impacting markets. Following two injections of capital, the US Treasury will convert up to $27.5 billion of preferred Citigroup shares into common stock issued under the Capital Purchase Program. This is on top of the $45 billion allocated to Citigroup in 2008 to shore it up. The move increases the bank’s tangible common equity from $29.7 billion to $81 billion and is intended to strengthen its capital structure. This means that the government has increased its ownership of close to 36% of Citigroup’s outstanding common stock. And this is before the stress test the government will conduct on banks with over $100 billion in assets. So potentially the government can control even a larger portion of the bank.
The main point made by the White House, Treasury and the Fed regarding this issue has been that nationalization is not the issue since the government will still be a minority shareholder. With the financial system still impaired, policymakers have few choices. In Canada, the market is currently discounting only a 25 basis points rate cut by the Bank of Canada next week. The thinking here is that with the Bank being so optimistic about a robust growth in 2010 (3.8%) and given the lagged impact of monetary policy, why cut by more? But given the weakness in the US and the clear deterioration in the Canadian labour and housing markets, we might see the Bank cutting by 50 basis points. The first quarter results from Canadian banks were generally better than expected, reflecting the strength of this sector in comparison to virtually any other financial sectors worldwide. This does not mean that Canadian banks will not face challenges in the coming six months. Retail banking activity is slowing, reflecting a significant softening in demand for credit as well as rising delinquency rates. The mortgage market will probably remain flat in the coming twelve months following a 14% increase last year. And the cumulative number of personal bankruptcies will probably rise by 20% or so in the coming twelve months.
Benjamin Tal
Senior Economist
