US and Japan still headed towards recession

Financial markets stabilised somewhat last week. Nevertheless, there are still significant challenges ahead, with the world's biggest economies looking more like they are headed for recession next rather than recovery.

Stock markets mostly gained last week. The Standard & Poor's 500 Index rose 4.6 percent, the Dow Jones Stoxx 600 added 4.5 percent and the MSCI Asia Pacific Index rose 1.5 percent.

Meanwhile, credit markets eased. The London interbank offered rate for three-month US dollar loans fell 40 basis points to 4.42 percent over the past week.

On 15 October, Federal Reserve chairman Ben Bernanke made a speech to the Economic Club in New York in which he mentioned the challenges to the United States economy posed by the ongoing financial crisis and outlined the actions taken by the government so far (see the full text).

While Bernanke was ultimately optimistic that the actions taken by the Treasury and the Fed "will lead to a much stronger financial system over time" and "help credit flow more freely, thus supporting economic growth", he also warned that "the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth", pointing out that economic activity "had been decelerating even before the recent intensification of the crisis".

Actually, Bernanke may have understated the weakness in economic activity. US employment is not just decelerating but has been on a steady decline since the beginning of the year. The housing market peaked in 2005 and both sales and prices of homes are now in declining trends.

Numbers reported last week show that this trend is continuing. The Commerce Department reported that housing starts fell 6.3 percent in September while the National Association of Home Builders/Wells Fargo housing market index fell from 17 in September to 14 in October, the lowest since the index started in 1985.

And declining numbers are no longer limited to employment and housing. Other indicators have recently joined the trend.

The beginning of this month saw the Institute for Supply Management report that its manufacturing index plunged to 43.5 in September from 49.9 in August.

Then last week, the Federal Reserve reported that industrial production in September fell by 2.8 percent, the biggest decline since 1974. This decline was not as conclusive as it might first appear though, since hurricanes and a strike at Boeing made significant contributions to it.

Still, following declines in the previous two months, it means that industrial output fell at an annualised rate of 6.0 percent in the third quarter.

And industrial production was not the only indicator that saw a big drop last week. Another ominous development has been the capitulation of the long-resilient US consumer.

Last week, the Commerce Department reported that retail sales fell 1.2 percent in September. It was the third consecutive monthly drop and the biggest since August 2005.

Such trends indicate that the US economy will probably enter a recession soon, if it is not already in one.

In his speech, Bernanke also said that even if government actions to stabilise the financial markets work, economic recovery "will not happen right away" mainly because credit markets "will take some time to unfreeze" but also because exports could slow as well "with the economies of our trading partners slowing".

The latter, though, appears to be another understatement. Both the euro area and Japan saw real gross domestic product decline in the second quarter by 0.2 percent and 0.7 percent respectively.

The latest data from Japan indicate that the decline will continue in the third quarter.

Last week, the Ministry of Economy, Trade and Industry reported that Japanese industrial production fell 3.5 percent in August, confirming the preliminary figure reported earlier. Separately, it also reported that its tertiary industry index fell by 1.4 percent in August. Both are now below second quarter levels.

The previous week, the Cabinet Office had released its composite indicators. Both leading and coincident indicators fell in August, the former to 89.3 from 91.4 in July and the latter to 100.7 from 103.5, maintaining their longer-term downtrends.

On Friday, Bank of Japan Governor Masaaki Shirakawa said in a speech that downside risks for the economy are rising and that it will remain "sluggish for the time being".

In other words, like the US economy, the Japanese economy is not looking like recovering very soon.