World economy gives investors a scare as eyes focus on US

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The doubts were evident across financial markets on Wednesday as a bear market in oil deepened, the Standard & Poor’s 500 Index came close to surrendering its gains for the year and bonds from Germany to the US rallied. The Chicago Board Options Exchange Volatility Index, a measure of investor nerves known as the VIX and often dubbed the Fear Index, is at its highest since June 2012.

US stocks pared losses after a report that Fed Chair Janet Yellen voiced confidence in the durability of the American expansion at a closed-door meeting in Washington last weekend. The S&P 500 closed 0.8 per cent lower on Wednesday after dropping as much as 3 per cent.

Avoiding commodities

A Bank of America survey of fund managers this week showed the lowest optimism in the outlook for economic growth and inflation in two years, pushing them to increase their cash balances and avoid commodities.

“Investors have huge questions about the world right now,” said David Kotok, chairman and chief investment officer at Florida-based Cumberland Advisors.

The latest catalyst for concern was the news that US retail sales dropped 0.3 per cent in September and wholesale prices unexpectedly fell for the first time in a year.

That added to the drumbeat of disappointing data from elsewhere, which this week alone included the weakest German investor confidence in two years and Chinese factory-gate prices dropping for a record-tying 31st month.

Japanese industrial production tumbled 3.3 per cent from a year ago, and UK inflation unexpectedly plunged to its lowest in five years. Prices in Israel and Sweden are even falling in an indication of deflation.

European epicentre

The epicentre of the economic worries is the euro area, where European Central Bank President Mario Draghi is trying to tackle the weakest inflation in almost five years as investors bet it will deteriorate further amid signs the powerhouse Germany is now faltering.

Having pulled the euro-area economy out of its debt panic in 2012, Draghi has sought to boost prices by cutting interest rates to record lows, issuing cheap loans to banks and laying the groundwork to begin buying private-sector assets this month.

That leaves purchases of government debt as the last option. While Draghi says he is open to quantitative easing if necessary, it would run into opposition from Germany. Governments throughout the bloc have yet to deliver the economic reforms and easier fiscal policy he would prefer to see first.

“Europe has now entered a more dangerous phase in their crisis,” said Scott Brown, chief economist at Raymond James & Associates in St Petersburg, Florida. “They’ve got to do quantitative easing. They don’t have any choice because that’s the only game in town.”

Emerging markets

Unlike five years ago when they proved strong enough to lift the world out of its slump, emerging markets are now stumbling, too. A property slump in China is pushing down the nation’s annual growth to what analysts project is the slowest pace since 1990, while Brazil is trying to escape the recession it entered in the first half of the year.

Some emerging markets are being sideswiped by subpar global growth as geopolitical tensions from the Ukraine conflict also weigh on investor confidence and threaten to sink Russia’s economy into a recession, according to Gustavo Reis, a New York-based economist at Bank of America.

“We’re seeing an impact not only on the Russian economy, which is pretty visible, but also on European confidence indicators,” Reis said. “That is having an impact on the global economy.”

Oasis of prosperity

The biggest reason for confidence that the storm will prove short lived are signs the US is again a potential oasis of prosperity even as the foreign weakness and rising dollar draw the concern of Federal Reserve officials.

Grounds for optimism include the lowest unemployment rate in six years, a deleveraging of debt by companies and households and the likelihood cheaper energy and low bond yields will support consumer spending and business investment.

“Things aren’t looking bad enough in the rest of the world to drag the US,” said Peter Hooper, chief US economist at Deutsche Bank and a former Fed official. “I wouldn’t say the world’s falling apart by any means.”

The growth scare in markets comes just days after finance chiefs were urged by the International Monetary Fund to find new ways to support their economies after the Washington-based lender again cut its outlook for global growth this year and next.

Budget deficits

The problem is even with inflation now close to its recessionary lows by some measures, governments and central banks are almost out of ammunition, having exhausted it by swelling budget deficits and cutting interest rates in the aftermath of the financial crisis.

In addition to the ECB, the Bank of Japan is holding off boosting its quantitative-easing program and China is refraining from broad-based stimulus. Germany is pushing back against calls to spend more.

“My concern is that the markets are looking for a ramping up of policy support elsewhere and that may not be delivered,” said Charles Collyns, chief economist at the Institute of International Finance and a former US Treasury official.

Less worried is Julian Jessop, chief international economist at Capital Economics in London. The US is robust, China is switching to more sustainable growth, cheaper oil should support demand and policy makers can ease policy if they really need to, he says.

“It’s hard to be positive given how negative the mood is in the markets, but I think sentiment is unnecessarily pessimistic,” he said.

Bloomberg News

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World economy gives investors a scare as eyes focus on US
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