No one is saying that a Bear Stearns situation is reappearing, but there is growing concern about the health of the US regional banking sector where several majors have taken big hits from dud subprime related loans and poor commercial property deals. Banking and finance indexes fell to five and 12 year lows in some cases Friday and in Britain and Europe there were more concerns as well.
The IMF said on Friday that continued economic weakness in the US would result in inflation risk going down, not up, in the coming months, and urged the Federal Reserve to keep interest rates on hold for the time being. The IMF also suggested that the greenback had declined to a level at which it was closer to, if not at, its medium-term equilibrium value (on a broad trade-weighted basis).
"The slowdown in activity in the United States has been less than feared, and recovery should begin next year as important headwinds are overcome," The Fund's statement started. "Considering the severity of the shocks that have hit, the economy has held up well so far, with substantial monetary and fiscal stimulus, buoyant net exports, and healthy corporate balance sheets all providing welcome support.
"However, their effect is being blunted by growing strains on household and bank finances, and now also by higher commodity prices. "These strains, which have yet to fully feed through to domestic demand and activity, will take time to work out.
"As such, we project that real GDP (Q4/Q4) will be roughly flat in 2008, and recover gradually in 2009 to around 2%. "Although inflation expectations have ticked up on surging commodity prices, we expect that price pressures will be contained as commodity prices peak and economic slack rises," The IMF said.
This now sees the Fund forecasting no growth at all in the US this year, measured from the final quarter of 2007 to the final quarter of 2008. The US Federal Reserve still believes there will be most growth this year, perhaps of around 0.5% or a bit more.
That is a modest upgrade from its prior projection, but it remains far below the average of private sector and US authorities' forecasts. That was the good news: the forecasts though were hedged in a way that would please Goldman Sachs.
"The unusual nature of the ongoing crisis in the financial and housing sectors leaves the outlook highly uncertain. "A more rapid recovery is clearly possible, given the substantial policy stimulus and proactive response of financial markets to repair balance sheets.
"However, the economy is facing historically unprecedented shocks, financial conditions currently presage further tightening, and there is the worrisome possibility that weakening activity will feed back into further bank losses, generating a longer slowdown."
Hence the concern about the return of worries about banks: the quickness of that concern to resurface in the US shows that confidence in banks and big financial groups (such as bond insurers and big insurers like AIG) is still very fragile.
Further ratings downgrades for bond insurers MBIA and Ambac and forecasts of rising losses at mortgage finance groups Fannie Mae and Freddie Mac hit the sector Thursday and especially Friday. The IMF's GDP forecast is more optimistic than the forecast it gave in its 2008 World Economic Outlook (WEO) this April when it forecast estimated Q4-over-Q4 growth of -0.5% in 2008, and slightly over 1.5% in 2009.
There are no hard and fast rules, but it would be very unusual to see the Federal Reserve raising rates with the unemployment rate rising higher," he said. And this could be all undone is there's a renewed breakout in world oil prices towards, and then above, the $US150 a barrel mark.
