Despite central bank interventions to stem the liquidity crunch arising from the United States subprime lending crisis, this is not likely to be the end of the volatility, according to Old Mutual Investment Group South Africa chief economist Rian le Roux.
“The shake-outs in the US financial and housing markets will continue and losses will mount further,” he says. “And given the institutional and geographic dispersion of subprime debt (thanks to securitisations and the globalisation of markets), losses will emerge sporadically and over time. As a result, both credit and equity market volatility is likely to remain high for some time.”
Le Roux notes that additional worries could stem from the actions of regulators seeking to identify further problem areas and ensuring full disclosure, which could uncover higher levels of problem debts than previously estimated. For now, he says, the US Federal Reserve has estimated total bank losses from the sub-prime crisis at approximately $100-billion, or 0,7% of GDP.
“Credit conditions will eventually ease, but the days of ‘easy’ credit globally are likely over,” he cautions.
A repercussion of the credit crunch will be a slowdown in global economic growth, albeit a moderate one. “Luckily this shock is occurring on the back of a strong global economy — particularly in emerging markets — and the impact is fairly broadly spread, which means it won’t be disastrous.”
In the US, the real risk lies in a wider and rapidly spreading credit crunch that envelops both prime household borrowers and corporates, he points out. The resetting of interest rates on adjustable rate mortgages could also force many to sell their homes, driving house prices down further.
“House prices have only declined moderately so far, but a severe slump in the housing market would harm consumer balance sheets and spending, and this is the biggest risk for the US economy,” notes Le Roux.
“Moreover, this pressure on the consumer comes on top of other recent shocks such as sharply higher oil and food prices, and the already severe housing-market slump. These combined effects may lead to a general underestimation of the macroeconomic and financial market impacts in today’s much more open and liquid global financial markets.”
Still, he believes, although the US housing slump and subprime crisis are both serious in their own right, having already created a number of high-profile casualties and more likely to come, their magnitude is not large enough to push the US economy into recession.
“Today, US consumer income growth is still strong, inflation remains low, corporate earnings are healthy and relatively expansionary policies (low real interest rates and a weak dollar) should prevent a serious growth downturn.
“What is more possible is that more cautious lending practices and the likely lengthy shake-out in the US housing market could become a lengthy macroeconomic drag. US GDP growth forecasts for 2008 are very likely to be lowered, and the probability has increased that the Fed may cut interest rates sooner.
“Global growth is therefore also likely to experience a bigger slowdown than previously expected, at least for the short term.
“And global financial markets, including South Africa, may experience more bouts of acute volatility on news flow and uncertainty,” concludes Le Roux.