Economic prospects: the
challenges & opportunities
July 2008
BUSINESS UNIT IN HERE
Trevor Williams, Chief Economist
Lloyds...
Page | 2
There are two overriding global economic themes at
present in my view, one is the credit crisis, the second
is th...
Page | 3
Assessing the impact of the credit crunch so far
Page | 4
Liquidity has drained out of financial markets…
Source: Bank of England
Page | 5
Credit risk has fallen but remains volatile and…
150
200
250
300
350
400
450
500
550
600
650
09/06/06
09/08/06
09...
Page | 6
….concern about liquidity has widened borrowing spreads…
Source: Bloomberg
UK corporate spreads over benchmark bo...
Page | 7
…raising the cost of funds
Source: DataStream & LTSB Corporate Markets
So mortgage spreads have risen for most bo...
Page | 8
Financial markets remain volatile – the dollar continues to slide
and equity markets are uncertain…
Source: DataS...
Page | 9
…fixed term rates are rising, short term interbank rates are up
Source: DataStream & LTSB Corporate Markets
%, 10...
Page | 10
What are some of the medium term implications of the
crisis – for regulation?
Page | 11
Lessons from the recent financial turmoil
Area of weakness Specific issues raised
Liquidity management • Underin...
Page | 12
What are the likely results?
Change in legislation as regulators try and catch up with the markets.
Greater tran...
Page | 13
What are the implications?
Global economic growth is likely to slow to around 4.3%, but should still
remain rela...
Page | 14
What are some of the medium term implications of the
crisis – for the financial players in the market place?
Page | 15
What are the implications for financial firms?
Those reliant on wholesale markets will see a sharp rise in the c...
Page | 16
So what’s in store for the world economy?
Page | 17
Global growth 2008; fast in emerging markets, slow in developed markets
Real GDP
North America 2007 2008 2009 20...
Page | 18
Emerging markets continue to outperform…
-2
-1
0
1
2
3
4
5
6
7
8
9
1971
1973
1975
1977
1979
1981
1983
1985
1987
...
Page | 19
…but inflation poses a serious risk to global economy…
0
2
4
6
8
10
12
14
16
18
1970
1972
1974
1976
1978
1980
19...
Page | 20
…especially in the emerging markets
% increase in year, inflation
2005 2006 2007 2008
0
2
4
6
8
10
12
14
China
R...
Page | 21
We project a weaker £, rate rise in the UK (2009), higher
EU (2008) & hikes in US rates (2009)
So what does this...
Page | 22
Possible triggers for a global economic crisis
• Asian/World inflation builds up unexpectedly
• Diversification ...
Page | 23
Disclaimer
Any documentation, reports, correspondence or other material or Information in whatever form be it el...
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Economic Prospects Challenges And Opportunities Lloyds Tsb Trevor Williams

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Economic Prospects Challenges And Opportunities Lloyds Tsb Trevor Williams

  1. 1. Economic prospects: the challenges & opportunities July 2008 BUSINESS UNIT IN HERE Trevor Williams, Chief Economist Lloyds TSB Corporate Markets
  2. 2. Page | 2 There are two overriding global economic themes at present in my view, one is the credit crisis, the second is the return of price inflation. The key risk is the latter. • The first stems from a bursting of the first asset price bubble of the new century. It was caused by too low interest rates from 2001 onwards, high liquidity and hence a ‘search for yield’, aided by complacency about risk • The second stems from fast growth in the world economy, that is now pushing up demand for commodities to fuel that faster pace of growth and, as a result of rising living standards, greater demand for better food and more goods. This is showing up in higher oil prices and in rising prices for manufactured goods exports. • The solution is tighter policy in the developed & developing economies and more open markets, like in agricultural goods. But will this be the outcome? Setting the scene
  3. 3. Page | 3 Assessing the impact of the credit crunch so far
  4. 4. Page | 4 Liquidity has drained out of financial markets… Source: Bank of England
  5. 5. Page | 5 Credit risk has fallen but remains volatile and… 150 200 250 300 350 400 450 500 550 600 650 09/06/06 09/08/06 09/10/06 09/12/06 09/02/07 09/04/07 09/06/07 09/08/07 09/10/07 09/12/07 09/02/08 09/04/08 09/06/08 10 15 20 25 30 35 Bps Index Vix, rhs, stock market volatility Itraxx, lhs, credit market riskiness Source: Bloomberg
  6. 6. Page | 6 ….concern about liquidity has widened borrowing spreads… Source: Bloomberg UK corporate spreads over benchmark bond yields 0 200 400 600 800 1000 1200 1400 1600 1800 2000 01/01/07 01/02/07 01/03/07 01/04/07 01/05/07 01/06/07 01/07/07 01/08/07 01/09/07 01/10/07 01/11/07 01/12/07 01/01/08 01/02/08 01/03/08 01/04/08 01/05/08 01/06/08 AAA AA A BBB BB B C Spread, Bps
  7. 7. Page | 7 …raising the cost of funds Source: DataStream & LTSB Corporate Markets So mortgage spreads have risen for most borrowers 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 2yr - 95% LTV Tracker 2yr - 75% LTV % bps spread, 3mth libor - base rates J F M A M J J A S O N D J F M A M J -60 -40 -20 0 20 40 60 80 100 120 £ $ € 2007 2008
  8. 8. Page | 8 Financial markets remain volatile – the dollar continues to slide and equity markets are uncertain… Source: DataStream & LTSB Corporate Markets Index Jan 07 = 100 J F M A M J J A S O N D J F M A M J 75 80 85 90 95 100 105 Yen Euro UK£ Brazilianreal Canadian$ Australian $ 2007 2008 Index Jan 07 = 100 J F M A M J J A S O N D J F M A M J 65 70 75 80 85 90 95 100 105 110 115 DJStoxx FTSE100 DowJones Nikkei 2007 2008
  9. 9. Page | 9 …fixed term rates are rising, short term interbank rates are up Source: DataStream & LTSB Corporate Markets %, 10yr gov't bond yields J F M A M J J A S O N D J F M A M J 3.0 3.5 4.0 4.5 5.0 5.5 6.0 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 UK, lhs US, lhs EU, lhs Japan, rhs %, 10yr gov't bond yields 2007 2008 %, 3mth interbank rate J F M A M J J A S O N D J F M A M J 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 0.5 0.6 0.7 0.8 0.9 1.0 1.1 UK, lhs US, lhs EU, lhs Japan, rhs %, 3mth interbank rate 2007 2008
  10. 10. Page | 10 What are some of the medium term implications of the crisis – for regulation?
  11. 11. Page | 11 Lessons from the recent financial turmoil Area of weakness Specific issues raised Liquidity management • Underinsurance against closures of key funding markets. • Inadequate recognition of contingent liquidity obligations to off balance sheet entities. • Scenarios used in the stress testing of funding insufficiently severe. Valuation of complex structured products • High dependency on models in valuation. • Extent of investors’ reliance on a narrow ratings metric. • Insufficient clarity in the composition and construction of instruments. Opacity of structured credit exposures • Inadequate disclosure of exposures and losses. • Lack of transparency in off balance sheet exposures. Crisis management arrangements • Insolvency arrangements for banks. • Deposit insurance regime. • Improvements in tripartite arrangements. • Underdeveloped practical arrangements for managing stress at an international institution.
  12. 12. Page | 12 What are the likely results? Change in legislation as regulators try and catch up with the markets. Greater transparency, for issuers, insurers, ratings, credit scoring methodologies, disclosure of who has debt, implications for balance sheets of exposure (confidential to regulator). Understanding and reporting of total leverage and so exposure of whole of firm risk is required in future, not just on balance sheet, but all products. Only then can proper analysis be taken of risk of defaults. Models have only be taking account of risk on balance sheet (i.e. regulated capital), totally missing overall risk. This is gross failure on an epic scale. Scenarios / stress testing must be more varied and ‘blue sky’.
  13. 13. Page | 13 What are the implications? Global economic growth is likely to slow to around 4.3%, but should still remain relatively robust, led by continuing solid economic performance from emerging markets. Financial strains are likely to remain until the fundamental questions of valuation and exposure are addressed – how much liabilities have to be brought on to balance sheets? Corporate and individual insolvencies forecast to rise, reflecting weaker economic growth, tighter credit conditions and high leverage. Risk of recession (receding fast) in those countries most affected by the ongoing turmoil in credit markets, notably the US.
  14. 14. Page | 14 What are some of the medium term implications of the crisis – for the financial players in the market place?
  15. 15. Page | 15 What are the implications for financial firms? Those reliant on wholesale markets will see a sharp rise in the cost of capital, lowering profits and leverage The higher the credit rating, the lower the cost of finance so higher rated will gain relative to lower rated companies There will be a return to relationship banking and deposit taking institutions will gain relative to wholesale borrowers. That may make retail banks more competitive versus investment banks. Private equity to gain too, as those seeking higher returns turn from credit instruments to old fashioned value investments. Sovereign wealth funds to remain a key feature of the future financial landscape Developing markets gain at expense of the developed markets, as crisis was in developed markets and made their assets cheaper Mortgage banks to lose out compared to older retail institutions, as they have moved into these new markets with weaker balance sheets and less experience Firms with global presence in emerging markets to gain relative to others
  16. 16. Page | 16 So what’s in store for the world economy?
  17. 17. Page | 17 Global growth 2008; fast in emerging markets, slow in developed markets Real GDP North America 2007 2008 2009 2010 2011 2012 United States 2.2 1.7 2.6 3.4 3.2 3.0 Canada 2.6 1.4 2.4 3.1 2.8 3.0 Europe Eurozone 2.6 1.7 2.0 2.0 1.9 1.9 Germany 2.6 1.8 2.0 1.5 1.5 1.5 France 1.9 1.7 2.0 2.1 2.0 2.0 Italy 1.7 0.7 1.5 1.4 1.3 1.3 UK 3.1 1.8 2.0 2.9 2.6 2.8 EU27 2.9 1.7 2.2 2.3 2.3 2.3 Asia Japan 2.1 1.5 1.9 2.1 2.1 2.1 Emerging Asia 9.2 8.6 7.5 7.3 7.2 7.2 China 11.4 10.8 9.1 8.7 9.2 9.2 India 8.9 7.9 7.6 7.6 7.6 7.6 World 2000 PPPs 4.8 4.2 4.1 4.3 4.3 4.3 Despite the credit crisis, growth to remain positive – no recession
  18. 18. Page | 18 Emerging markets continue to outperform… -2 -1 0 1 2 3 4 5 6 7 8 9 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 % increase in year Emerging and developing World Advanced F'cast
  19. 19. Page | 19 …but inflation poses a serious risk to global economy… 0 2 4 6 8 10 12 14 16 18 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Advanced economies Developing economies Annual average, % F'cast
  20. 20. Page | 20 …especially in the emerging markets % increase in year, inflation 2005 2006 2007 2008 0 2 4 6 8 10 12 14 China Russia Brazil India % increase in year, inflation 2005 2006 2007 2008 -2 0 2 4 6 8 10 12 14 16 18 20 Singapore Philippines Argentina Indonesia
  21. 21. Page | 21 We project a weaker £, rate rise in the UK (2009), higher EU (2008) & hikes in US rates (2009) So what does this all mean for the $, £, euro and their interest rates? 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 12.03 6.04 12.04 6.05 12.05 6.06 12.06 6.07 12.07 6.08 12.08 6.09 12.09 EndquarterexchangeratesvUK £ Forecasts £ buysUS$ £ buyseuro 0.0 1.0 2.0 3.0 4.0 5.0 6.0 12.03 6.04 12.04 6.05 12.05 6.06 12.06 6.07 12.07 6.08 12.08 6.09 12.09 Shortterminterestrates,% Forecasts UK US Euro
  22. 22. Page | 22 Possible triggers for a global economic crisis • Asian/World inflation builds up unexpectedly • Diversification away from US assets/fall in USD, due to housing market collapse, fiscal and external deficits • A further leg to the credit crisis could exacerbate economic slowdown, i.e. another credit crisis • Oil prices – have been rising to record highs recently. Iran a wildcard? • EU risk from over tightening and strong currency? • UK fiscal policy too loose, currency at risk of even sharper fall? • Commodity prices are rising, oil, metals, food, does this pose a bigger threat? • China slows sharply, derailing global economy
  23. 23. Page | 23 Disclaimer Any documentation, reports, correspondence or other material or Information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authorities and a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business. Please further note that this document does not constitute an accounting opinion. Its purpose is to provide guidance in finding the appropriate products to comply with your risk management policies and strategies, to identify the important aspects relating to the processes to be followed under US GAAP/IFRS and as a pointer for discussion and clarification of the position of your auditors. It should not be used for any other purpose. Lloyds TSB does not accept any liability from the use of this document.

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