OECD versus Mr Market : 0 - 1

Last week, the OECD launched its revised economic outlook for 2010. Compared with the November 2009 outlook, it's more upbeat : upward revision growth from 1,9% to 2,75% for the OECD area in 2010 and 2011. Baseline scenario : US growth to remain buoyant, Japanese business investment to pick up, euro-zone activity expected to pick up through strong external demand, " assuming recent financial distress will not durably impair confidence. Further, for the baseline scenario to materialize, outside OECD area growth is to remain solid (Bric) and fiscal issues should be addressed swiftly", dixit OECD.

There are however some conflicting signs emerging from out of the market. The inventory cycle seems already to have peaked in the US which points to business cycle weakening in the second half of 2010. But more interestingly, commodity prices have experienced a very strong downward correction over the past month. The chart below tracks the Journal of Commerce Industrial Price Commodity Smoothed Price index. The index is a good indicator of what is happening on supply and demand because in contrast to futures, 50% of the index constituents don't trade on exchanges used by speculators.

Last month, the index dropped from 60 to 26 or -57%. To put this into perspective, in the aftermath of Lehman the index dropped 56% in October 2008 which at that point in time was the lowest level since 1949. Two months later, the National Bureau of Economic Research said the US was in recession. So what is the message the market is sending out in response to the OECD :

1) The business cycle peak is imminent or already behind us, hence slower global growth in the pipe-line. The European debt crisis - in combination with the recent disappointing numbers coming out of China and measures to cool things down - will also put a damper on global growth.

2) Concerning "fear for what is about to come next", all dashboard lights are still flickering red, especially concerning the banking crisis revival and its impact on other markets (corporate bonds - sovereign debt). Gold is on the move in the wake of the sovereign debt crisis which is closely interconnected to the banking crisis. The first chart beneath tracks the evolution of 5y CDS protection of senior European financials. In the month of May and as we speak, the index is close to the all time high of the panic (March 2009) and exceeds the level of Bear Stearns and Lehman events. This has pushed corporate bond spreads higher and as a result, new corporate emissions come to a standstill : no issuance yesterday after the warning issued by the ECB report (more bank writedowns to come) ; 70 bio $ issuance in May, less than half of April issuance and the least since August 2003.

3) Briefly, appetite for corporate risk is fading fast and markets are starting to freeze. Concerning the latter, a second chart below shows how the US interbank market - expressed in bio USD interbank loans - is still not properly functioning : it hits a 16 year low, still in a coma after the Lehman "Black swan"

To summarize : The world still faces strong headwinds in the months to come, making a V-shaped recovery not very likely. With the financial crisis entering a second stage (banking crisis revival, sovereign debt), forecasting economic growth will inevitably be subject to a considerable amount of future volatility as well.