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Investors worldwide are assessing the reality of a recession in the United States, the third round of bad news that the world’s largest economy has delivered since the onset of global financial turmoil in August.
When credit markets seized up in late summer, the product of mounting losses linked to the US mortgage market, stocks took a dive, then recovered, as investors factored higher borrowing costs into the outlook for corporate earnings. The change, they reasoned, was a logical step away from the easy money of recent years.
As large US banks chalked up losses in November, equity markets plunged again to account for a financial system that, it turned out, needed to purge losses and be recapitalized. Then stocks recovered again in December.
Now, the focus has jumped to recession - and the conviction that the United States cannot avoid it has became embedded in investor psychology around the world.
‘We have moved from a phase where an assessment was made on the credit situation, which is improving, onto the macroeconomic news flow,’ said Jacques Cailloux, chief euro area economist at Royal Bank of Scotland in London. ‘And if you look at the United States, the data has not been very encouraging.’
On Monday, investors ignored the assurances delivered last week by the Federal Reserve chairman, Ben Bernanke, that the US might avoid recession. Instead investors began to ask how bad it could get in the United States. And how bad would that make it for the rest of the world?
‘Ten days ago only a very few people thought this would be a bad one,’ said Erik Nielsen, chief Europe economist at Goldman Sachs in London, who just returned from a trip to the United States. ‘But now you have people debating just that.’
The latest panicked discussion - which ushered Asian and European markets Monday to some of their steepest losses since September 2001 - revolves around whether the normally resilient US economy will suffer a sharp, protracted downturn or a brief, shallow slowing if consumers regain their footing following a long period of spending freely by borrowing against the value of their homes.
Emergency proposals by both the Republican White House and Democrats to stimulate the economy, coupled with further signs that the Fed might aggressively cut borrowing costs to cushion the blow, suggest that US officials agree that a downturn is a serious threat, and must be addressed immediately.
That sense of urgency is also fueling further debate among policy makers in Europe and Asia about whether their economies are truly as insulated from US woes as many would like to believe.
Investors in Asia, conditioned by the roaring economies of emerging markets like China and India, had resisted calculating probabilities of a recession in the United States into equity prices, stock strategists said, a stance that helped ward off losses in recent months.
But now that belief in a recession is widespread, the adjustment to a new reality has been jarring - a point evident in stock losses on Monday.
For more than a year, the European economy also looked like it had finally come to stand on its own, having grown increasingly resilient as companies restructured to hedge against currency swings, and consumers built a virtuous cycle of jobs creation and spending.
Even after the first winds of turmoil began hitting credit markets last summer, economic officials, including the European Central Bank, could point to evidence that Europe had grown resilient enough to withstand ripples from any US slowdown.
But with near daily market gyrations stemming from fears the United States would tip into a recession, even some of the most optimistic officials are growing leery.
‘We are worried in the sense that we have to follow every hour,’ Pedro Solbes, the Spanish economy minister, said Monday in Brussels, according to Reuters.
The signals from the United States have been strong enough that financial markets are betting that Europe will take a much bigger hit than previously expected.
So strong is this conviction that investors are behaving, based on signals given by bond markets, as if they expect the European Central Bank to ease interest rates later this year, even though the bank has given no such signal.
‘Over all, the market is sending a message to the ECB that the outlook is very different from what the bank has said,’ Cailloux said. ‘The markets are pre-empting the ECB.’
Instead, the ECB has threatened to raise interest rates - rather than lower them, as is happening in the United States - if European labor unions demand compensation for food and energy price increases in new wage settlements, a move that would fire inflation, already running at 3 percent in the euro zone.
Yet even the president of the ECB, Jean-Claude Trichet - who maintains that the 15-nation euro area can continue to grow solidly despite deteriorating conditions in the United States - acknowledged in a recent speech that the slowing in the United States must be monitored carefully.
In assessing how much US consumers might curb their spending, which would slow the economy further, some analysts are beginning to make comparisons to Japan’s long stagnation of the 1990s.
This view holds that consumers have binged so hard on cheap credit and ever more expensive homes, that the adjustment could drag out more than a few quarters. At the very least, according to this thinking, corporate earnings could also be tame even after the economy stops contracting outright, which would slow any recovery.
‘The real key question is not whether there’s going to be an economic recession - it’s not when the economic recession is going to end,’ Hugh Johnson, chief investment officer of Johnson Illington Advisors of Albany, New York, told The Associated Press. ‘It’s when is the earnings recession going to end.’ - New York Times
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