US Recession A Reality, Says Merrill Economist

Source : The Business Times, May 15, 2008

He expects house prices to fall another 15-20% over the next 20 months

THE worst is far from over for the US economy, which is facing its worst consumer-led recession in more than three decades, the top economist for North America at Merrill Lynch said yesterday.

Mr Rosenberg: Recession is a reality and no longer a forecast

Despite aggressive efforts by the US government and central bank to boost economic growth through tax rebates and interest rate cuts, a mix of falling house prices due to excess housing stock, tighter lending standards by banks, and weak consumer sentiment will cause US consumer spending to contract, with large knock-on effects for the overall economy, said David Rosenberg, Merrill Lynch's chief economist for North America.

'I believe the recession is a reality, no longer a forecast,' he said.

He delivered his stark warning at this year's Rising Stars conference organised by Merrill Lynch, which ends on Friday.

'I think this could end up being a consumer recession the likes of which we had in 1973-75.' That contraction lasted 16 months, ending in March 1975.

Spending by US consumers drives about 70 per cent of the country's economic output, as measured by its gross domestic product (GDP).

The main driver of his forecast is his pessimistic view of the US housing market. Large stocks of unsold housing have led to a supply glut that will drive prices even lower, he said.

'In my opinion, we're about halfway through the real estate deflation.' By his estimates, based on current housing sales rates and the stock of unsold vacant units, 'another 20 months of excess supply has to be worked out of the system' and he expects house prices to fall by another 15-20 per cent over that period.

At the same time, the tightening of lending standards by banks on loans to businesses and consumers and slowing demand for credit mean that the impact on the broader economy of the rapid succession of interest rate cuts by the US Federal Reserve has so far been muted, he said.

Since last September, the Fed has slashed its key interest rate by 3.25 percentage points to 2 per cent. By his estimates, however, average borrowing rates for individuals and firms in the private sector have only come down about 0.65 percentage point.

'The credit crunch has not totally gone away and it's mitigating to a very large extent the traditional monetary policy transmission mechanism to the real economy,' he said.

And despite 65 quarters of uninterrupted growth in US consumer spending, discretionary or non-essential consumer spending 'most assuredly is in a recession', he said, citing data from the official first-quarter GDP estimates, which put overall real GDP growth at 0.6 per cent.

Over the past six years at least, US consumer spending has been driven mainly by ever-increasing levels of debt rather than income - a trend that has now peaked with the end of easily available credit, he said. 'This was not about resilience (of the US consumer). This was about the most pronounced, debt-financed consumer spending cycle of all time.'

Not only is the supply of easy credit drying up, 'demand for consumer loans is bordering on historic lows' as people struggle to meet their existing debts on everything from mortgages to credit cards, he said.

'This is a long story of a post-bubble de-leveraging. The story's not over.'

In US equity markets, 'I still find at this stage that no asset class or security is fully priced for a recession scenario' with the possible exception of financials, he said.

He expected the pace of job losses in the US, while not yet 'dramatic', to accelerate in the coming months. That will act as 'a very strong offset' to the impact of the US government's tax rebates in the second quarter, he said.

With higher unemployment and stagnating wage growth, price inflation in the US is far less worrying than the other economic risks, he said.