Merrill Lynch Research Expects Global Economic Imbalances to End in 2009 as Growth Falls to 27-Year Low

A new report by Merrill Lynch (MER) Global Research predicts that emerging market savings will no longer finance excess consumption in the U.S. Global growth is projected to fall to its lowest level since 1982, before rebounding in 2010.

Merrill Lynch forecasts global growth of 1.3 percent in 2009, down from 3.2 percent in 2008, rising to 3.1 percent in 2010. Even this level of growth would be half a percentage point lower than the average of the past four years. In the report "2009: The Global Macro Year Ahead,” Merrill Lynch has identified four further themes for 2009:

"We are witnessing an end to global imbalances as U.S. consumers adjust their habits and emerging economies turn inward,” said Alex Patelis, head of international economics at Merrill Lynch. "Japan, emerging Asia and Latin America will be the least vulnerable to this shift, while EMEA and the U.S. will be the most vulnerable.”

The end of global imbalances

The financial crisis is prompting U.S. consumers to repair their personal finances by saving more and spending less. The market will not allow U.S. policy makers to inject the quantity of money needed to maintain existing spending levels. In the long run emerging markets will rely less on Anglo-Saxon consumption. In China especially, Merrill Lynch expects lower interest rates and higher government spending to stimulate domestic demand.

Differentiation between strong and weak economies

Leveraged countries such as Australia, Switzerland, Korea, Hungary and the euro area are among the most vulnerable economies. Less leveraged countries, such as Nigeria, Mexico and the Philippines, are the least vulnerable. Since developed economies are contracting, emerging markets are on course to deliver more than 100 percent of global growth.

Massive policy stimulus

Global rate cuts are expected to fall significantly further. Rates have fallen by more than 0.8 percent so far and could fall by a similar amount again. Fiscal stimulus packages will continue now that the orthodoxy of fiscal discipline has been abandoned. Government intervention policies are likely to focus on measures to strengthen household budgets.

Limits and side effects of stimulus

Governments face higher borrowing costs as a result of taking on greater risk by buying into the private sector and increasing budget deficits. Central banks will not accumulate reserves and might even deplete them. Too much policy easing can weaken currencies – Merrill Lynch expects the U.S. Dollar to face this constraint. Some governments will inflate their economies too much and others too little, as it is almost impossible for policy makers to get the size and timing of stimulus right.

Cycles twists and turns

Past recessions suggest that growth will rebound in the first half of 2009 as stimulus policies take effect. Policy constraints could temper that recovery before the "all clear” emerges, most likely in mid-2010. At the same time, the report recognizes the difference in nature between a traditional cyclical slowdown and the displacement shock created by the financial crisis.

U.S. stimulus needed to avoid deflation

The U.S. recession is set to last through 2009 before a recovery in 2010. "A surge in personal savings needs to be offset by massive stimulus policies to prevent deflation,” said David Rosenberg, chief North America economist at Merrill Lynch.

Some argue that the global crisis shows Latin America’s recent progress is a mirage. Felipe Illanes, chief Latin America economist at Merrill Lynch, said, "We disagree – most countries in the region are fundamentally more resilient now, though a small number are vulnerable.”

Japan can avoid negative growth

Merrill Lynch predicts Japan can narrowly avoid recession, for three reasons. First, Japan depends on exporting to Asia rather than the U.S. Secondly, lower oil prices are expected to boost personal consumption, as is fiscal stimulus.

"The combination of lower commodity prices and a stronger Yen should act as an indirect tax cut for the Japanese economy,” said Masayuki Kichikawa, Japan economist at Merrill Lynch.

Chinese government to limit slowdown

An aggressive package of expansionary policies should limit the slowdown in Chinese growth. "We think China’s fiscal response will prove effective,” said T.J. Bond, Asia Pacific economist (ex-Japan) at Merrill Lynch. "By contrast, smaller, open economies in Asia are more vulnerable.”

Across Asia, the success or failure of policy, the rise and fall of country risk, and the emergence of valuation extremes will determine the region’s economic fortunes.

Full blown recession unfolds in euro area

A full blown recession is unfolding in the euro area and in parts of emerging EMEA. "In the euro area we believe that export growth is about to collapse and that the credit crisis will limit investment,” said Klaus Baader, chief Europe economist at Merrill Lynch. "Consumption should benefit from lower oil prices, however.”

Hungary and Turkey are facing recession while governments in Russia and Gulf States are willing and capable of limiting the downturn.

Oil price to bottom out in first half of 2009

With demand vanishing across all key oil consuming regions, Merrill Lynch is lowering its crude oil price forecast to U.S. $50 per barrel for 2009. "The key question is ‘how low can oil go?’” said Francisco Blanch, head of global commodities research at Merrill Lynch. "The major downside risk would be a weaker than expected Chinese economy. But in our opinion, oil prices should reach a trough by early in the second quarter.”

Global rebalancing leads to weaker U.S. dollar

Merrill Lynch expects the U.S. dollar to first strengthen and then weaken as risk aversion subsides. "Changing habits of consumers around the world will be the principal force behind currency movement in 2009,” said Daniel Tenengauzer, head of global currency strategy at Merrill Lynch. "Currency values will reflect global rebalancing, lower spending and depleted risk appetite.”

NOTES TO EDITORS

Merrill Lynch Global Research has consistently achieved high rankings for its equity and fixed income research in numerous regional and global investor surveys, such as Institutional Investor, The Wall Street Journal, LatinFinance, Asiamoney, Euromoney, Extel and Reuters.

Merrill Lynch is one of the world's leading wealth management, capital markets and advisory companies, with offices in 40 countries and territories and total client assets of approximately $1.5 trillion at September 26, 2008. As an investment bank, it is a leading global trader and underwriter of securities and derivatives across a broad range of asset classes and serves as a strategic advisor to corporations, governments, institutions and individuals worldwide. Merrill Lynch owns approximately half of BlackRock, one of the world's largest publicly traded investment management companies, with approximately $1.3 trillion in assets under management at September 30, 2008. For more information on Merrill Lynch, please visit www.ml.com.