Wednesday, August 10, 2011

Economic Update

Dear Friend,

I hope this email finds you well and enjoying the bits of sunshine in between the clouds.

Speaking of clouds, there is no doubt there is a large grey one over the US and Europe. This past week has been especially precarious with huge ups and mostly downs in the stock markets that suffered a major free fall yesterday as a result of the credit rating down grade. That being said however, a small gain was made today with expected volatility to continue.

Although there has been a very swift turn to the negative, we should be used to the turmoil since the fallout in 2008. It is important to note that Canada and US banks - to a lesser degree - are in a stronger position then the 2008 financial crises. The banks have billions on cash reserves and are much better prepared for financial difficulties. We are seeing the bond market go even lower and US debt even carries a negative return as there is that much demand to buy US debt.

As far as interest rates go, this is a sign that we are going to continue in a recorded low interest environment for an extended period o f time. Now is not a time to panic or let fear make your choices. Look at the log term view of your financial goals and make choices that fit within those parameters.

See below for a great perspective on the markets from Craig Alexander, Chief Economist TD Bank.

Get current interest rates now, call 604 536-3802

Financial reaction to u.s. credit downgrade

Yesterday morning financial markets appeared to be set
for a moderate correction in the wake of the S&P downgrade
to the U.S. sovereign debt rating. Asian, European and North
American equity markets were generally down 2-3% when
we wrote our note on the financial reaction to the downgrade.
However, the initial North American sell-off became a rout
over the course of the afternoon that reeked of fear.
In our commentary, we stressed that in, and of itself,
there was no rational reason for the lower credit rating to
provoke panic selling. The US government is solvent and
the risk of default remains negligable. Indeed, the associated
probability of default associated with a AAA rating
versus a AA+ rating is miniscule. Moreover, the fact that
other credit agencies did not follow suit limited the financial
consequences of the downgrade.
Accordingly, the market reaction yesterday can only be
interpreted as a crisis in confidence. It was a vote of nonconfidence
in the ability of governments to deal with their
fiscal problems. It was also a vote of non-confidence in the
sustainability of the economic recovery. This was the worst
possible outcome at the worst possible time.
The U.S. economy is extremely fragile. This can be seen
by the fact that the combination of $4 per gallon gasoline,
a supply chain shock from Japan and bad weather in the
Winter and Spring were capable of stalling U.S. economic
growth in the first half of the year. The expectation was that
the waning of these factors would lead to markedly stronger
economic growth in the second half of 2011. However, the
financial rout has put this improvement in peril.
The issue is once again about confidence. The financial
turmoil runs the risk of negatively impacting the psyche of
consumers and businesses. If consumers and businesses
cut back their spending because of worries about a renewed
recession, it can easily result in the precise outcome that they
are fretting about. It could also aggravate the correction in
US housing, lead financial institutions to cut back on their
willingness to lend, and worsen the US fiscal situation -- in
other words, add to the various structural headwinds on the
The traditional response to bolster confidence is verbal
support from policymakers or, if that doesn’t work, an easing
in fiscal or monetary policy. Given that there has been a
loss of confidence in the ability of governments to address
their problems, verbal support has had little impact so far.
Both the G-7 statement on Sunday and Obama’s speech on
Monday were entirely ineffective. This leads to the matter of
policy actions. The bad news in America is that the scope for
additional monetary stimulus is limited and fiscal stimulus
is not likely feasible in the current political environment.
The bottom line is that the rout in financial markets has
materially increased the risks of a renewed US economic
downturn, which would have global ramifications. The
sad truth is that it doesn’t have to be this way. The current
environment harkens back to FDR’s speech in the 1930s
that, “the only thing we have to fear is fear itself—nameless,
unreasoning, unjustified terror which paralyzes needed efforts
to convert retreat into advance”. The US government
is not insolvent. There is time to deal with the fiscal challenges.
And, the message from S&P and financial markets
that greater fiscal progress is required will not be lost on
policymakers. Given today’s Federal Reserve decision, the
immediate question is whether Bernanke can restore some
of the lost confidence. The main message to investors, consumers
and businesses is don’t panic, try to have a bit of
faith, and remember that you can be your own worst enemy.
Craig Alexander
SVP & Chief Economist
TD Bank Group

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