(G) 7 Dwarfs

by UniCredit Research.
UniCredit Group
The G7 leaders meet today as their economies are shrinking fast, and the latest set of Q4 GDP growth data bring painfully home the fact that this is the deepest and most synchronized recession they have faced in a long time. This should emphasize beyond doubt the need for a common response, and yet it is clear that protectionism and financial isolationism have already emerged as the next biggest threat to a recovery. Protectionism should therefore be at the top of the agenda, and the G7 needs to send a clear and unqualified message that protectionist measures will not be allowed to escalate, thereby laying the basis for a broader agreement at the G20 in April. On the FX front, I would expect a cooling of tensions on the CNY after the apparent opening salvo of the US administration in its very first days. Pressuring China for a significant FX appreciation at this juncture would be counterproductive in both diplomatic and economic terms, and would raise the risk of UST-unfriendly comments that could spook an already nervous bond market. I do not expect major tensions or pronouncements on other currencies like JPY and GBP, as most G7 currencies are now being buffeted by the economic downturn and by investors’ concerns, leaving little room for engineered competitive devaluations. Greater coordination would be desirable also on financial sector stabilization and fiscal stimulus, but, given the experience of the last four months, this weekend is likely to be little more than a chance for leaders to compare notes on their individual efforts on both fronts. So it is on protectionism that we should look for the strongest commitment—or the greatest disappointment. Failure to agree on a strong commitment to uphold free trade would undermine the G7’s leadership, and their political stature might appear to shrink as fast as their economies.
European growth data released today have brought a humbling lesson for policymakers who had boasted of the eurozone’s resilience and lack of imbalances, and who now look at the gloomy US prospects with grave concern and no longer with shadenfreude. Eurozone GDP shrank a worse than expected 1.5% QoQ in Q4, that is just over 6% on an annualized basis—exactly what we expect to see in the US, where the - 3.8% of the preliminary estimate seemed excessively benign. Of the three largest eurozone economies, only France did better than this, with a relatively moderate 1.2% contraction, about 5% annualized. Germany’s growth crumbled, recording a 2.1% drop QoQ, which is a stunning near-9% drop on an annualized basis. Italy was almost as bad, with a 1.8% drop QoQ, or some 7 ½ % annualized (see chart on the next page).
While Q4 was most likely the nadir, and the contraction now appears to be losing speed, the economic and social consequences of this dramatic downturn could prove extremely disruptive. US unemployment has already jumped by nearly 2 percentage points in the last six months, the fastest pace of deterioration in the last 35 years, and it will probably climb further to about 9%. Structural rigidities are slowing the adjustment and cushioning the blow in the eurozone, but there as well unemployment will rise significantly and climb back into double digits by next year.