Trending down

April 15, 2009

The global economic crisis has prompted  a number of economists to argue that the world will from now on experience lower trend growth, that is, roughly, that normal growth will be lower. The argument is that the current crisis is structural, not cyclical.

UBS is the latest to latch on to this view. In a client note, the bank’s economists say they have revised their 10-year average global real growth estimates to 3.4 percent from 3.8 percent. They have done the same for most of the big economies. The U.S. economy is now seen averaging 2.3 percent versus about 2.8 percent; China goes to 7.5 percent from 8.0 percent.

Does this matter? In at least one area it does — calculating the needed yield for U.S. Treasuries to be attractive over stocks. The lower the growth rate the lower the needed yield.

Alan Brown, who as chief investment officer of fund firm Schroders steers around $161 billion in worldwide assets, reckons U.S. trend growth is now 2.5 percent. With that 2.5 percent and other factors such as moderate inflation, he calculates that long-term U.S. Treasury yields should be heading towards 6 percent. Today’s yield is 2.8 percent, meaning trouble waiting to happen.

A lower trend growth rate such as UBS estimates would lower that long-term yield. But not that much.  Even at 5.8 percent (if UBS is right) U.S. paper could be in for what Brown reckons is a “painful” retreat, could it not?.

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