Focus: On the global rebound

Contrary to investor sentiment, the economic outlook has remained largely unchanged. It is expected a depression will be avoided, the financial crisis will continue to ease, America will rally by the second half of 2009, and the rate of growth will be sluggish, as a reflection of a strong inventory cycle and weak final demand. Further, there will be persistently high unemployment for several years yet.

A few months ago depression was a conceivable scenario, but many believe this no longer to be true. The basic reason the depression risk has passed is policymakers - especially in the US and China - acted swiftly in correctly diagnosing the debt deflation risks, and prescribing and implementing monetary and fiscal policies to reduce these risks. The 'Great Recession' will be the longest and deepest of the post-war recessions, but no worse than that.

The financial crisis has started to ease. Initial improvements were in markets benefiting directly from government or central bank support. More recently, there have been substantial improvements in unsupported at-risk markets (investment-grade corporate bonds, high-yield bonds, jumbo mortgages, commercial paper, volatility). Risk spreads are off their peak levels in nearly all markets. This broad pattern provides clear evidence risk aversion is easing. The financial panic has crested and the economy and markets have transitioned into a phase of orderly deleveraging.

The longest and deepest US recession of the post-war era will end mid-2009 as inventory liquidation eases in the aftermath of the shutdown of many domestic auto plants. Inventory liquidations tend to be unstoppable when they are underway but have always proved temporary. It is clear the pace of intense inventory liquidation in the first half of 2009 is unsustainable.

As usual in the early recovery, the large reduction in inventory liquidation should contribute to the transition from declining economic activity to rising economic activity. Already, purchasing manager indices are rising across the world from their cyclical lows. It is expected this pattern will persist, since the inventory liquidation has been excessive, and final demand is beginning to stabilize.

In the US, front-end sectors such as autos and residential construction have reached such depressed levels that some rise is likely from mid-2009 to year-end 2009 and continuing through to 2010. However, late-cycle sectors vulnerable to the large excesses in global and domestic productive capacity, such as private nonresidential construction and capital spending, should remain weak.

There has been a clear historical pattern that the sharpest recessions have been followed by the strongest rebounds. The classic cyclical precedent after such a severe recession would call for an initial growth rate of 6 per cent or more in the early recovery. However, the consensus is that this will not occur in this instance. Instead, a rebound at roughly half that pace is expected.