Recession in the air

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It was a pleasure listening to the Bank of England governor, Mervin King, last week. None of the contemporary central bankers had spoken with so much clarity, calling a spade a spade.

Without mincing words, he said that the bank wouldn't amend its system for financing commercial banks as that would encourage risky behaviour in the future.

Across the Atlantic, in the US, Ben Bernanke was in a serious dilemma until last week, whether to cut rates to temporarily resurrect housing or let the pain continue and soak the excesses of his lecture-hungry predecessor.

Former Fed chief Alan Greenspan, father of all the current problems, had the audacity to say that there are many similarities between the current market situation and those of the years when the stock market crumbled. You can curse and admonish him for trying to earn brownie points now, but the fact is that similarities exist and stock markets could tumble as the octogenarian suggests.

After 47 months of continuous job growth, the US economy sputtered in the month of August and failed to create new jobs. While it may be a tad premature to utter the "R" word, recession does seem to be round the corner.

Cool-minded economists say that one piece of data does not make a trend, but it could scare the Fed into believing that the worst is yet to come. The debate now is not whether the Fed will cut or not, the question is how much?

The weak jobs data has solved Bernanke's dilemma. When he cuts interest rates, he will no longer be under the spell of guilt and be seen helping those who had taken an unwarranted risk. In the light of the weak job numbers, he will be seen rising to the occasion and helping the nation to avoid a recession.

A Fed rate cut could prop up the housing market just enough to avoid a big increase in foreclosures and layoffs from construction companies. But the Fed's rate cuts can't produce a miracle. The credit crunch on Wall Street reflects an unwillingness to lend because of a lack of trust, not a lack of funds.

Both Bernanke and Bush have spoken about reworking the sub-prime loans. Good intentions, but how are you going to act on them? Around 80 per cent of the $8 trillion residential mortgage debt has been securitised and may be sitting in portfolios of Korean insurance companies, Taiwanese funds, German banks, US pension funds and in the overseas portfolio of some Indian banks as well. Only the portion of mortgages that has not been securitised can be easily reset.

The problem with recession identification is that by the time it is diagnosed and shows up convincingly in the data, it could well be fully entrenched.

Don't take the threat of US recession too lightly. Of the past 10 recessions, eight have been preceded by overinvestment and then a slump in housing.

At the time of writing, crude had closed above the $80 mark. Commodity watchers have blamed the reduction in inventories as the reason for the rise, which has come about even as the OPEC decided to augment its production by 0.5 million barrels a day.

The real reason for the rise is the official admission by the OPEC that it had been producing 27.2 million barrels a day and not 26.3 million barrels all along. This means that OPEC's production was higher by 0.9 million barrels a day and the price had reached these levels. So a 0.5 million further rise in production may not help contain prices.

More importantly, it goes on reducing the spare capacity available to the world by 1.4 million barrels a day. As the spare capacity reduces, it increases the chances of an upward spiral on the smallest of geopolitical sparks.

Indian markets are inherently stronger and any depreciation of the dollar will make our markets further attractive to FIIs. But in the short run, a selloff in the

US markets, if it happens, will find an echo in our markets as well. To that extent, we are still tied to the apron strings of Uncle Sam. Mid-caps, especially from the upstream oil business and the service companies, can out-perform the broader market in this scenario.