Global equity markets reached a 10 month high Monday and the rally shows no sign of running out of steam. The equity market rally is supported by recent economic reports on housing and manufacturing which showed surprising gains, the rise in the price of crude to the highest level since last October and a declaration from the central bankers meeting in Jackson Hole Friday that the recession has ended. USD has weakened trading inversely to the improvement in the equity markets and risk sentiment. USD downside was limited in Monday's trade by uncertainty about the global recovery. There remains a great deal of uncertainty about the potential strength of the global recovery with the outlook in China becoming more uncertain and two well-regarded economists warning of the risk of the double dip recession.
Roubini and Feldstein warn of double dip recession
The outlook for the global recovery remains uncertain but current consensus is that the US and global economy will not experience a double dip recession. Two leading economists however have warned of the risks to the global economy and the possibility of a double dip recession. New York University's Stern School of Business professor Roubini writing in the Financial Times Sunday edition warned that there is a big risk of a double dip recession. Roubini said the risk of a double dip recession is rising because of risk related to withdrawal of global monetary and fiscal stimulus. According to Roubini, the global economy will bottom out in the second half this year but he expects the recovery to be anemic and forecasts below trend growth for the EU and the US. Roubini is concerned that if policymakers exit fiscal and monetary policy too soon it will put the recovery at risk. He is also concerned that if policymakers try to fight rising budget deficits by raising taxes it could also undermine the recovery. The Obama administration raised its 10 year deficit forecast to 9 trn and the UK posted a record budget deficit in July. Roubini warns that if large deficits grow unchecked it will increase the risk of inflation and interest rates will rise with policy makers punished by the bond vigilantes. Rising interest rates would choke off growth. Roubini went on to say that the excess liquidity created by massive fiscal and monetary stimulus may be fueling the rise in crude and commodity prices that is not warranted by fundamentals. Roubini says the global economy could not withstand another contractionary shock of crude oil prices rising above $100 a barrel. Economist Martin Feldstein echoed Roubini's concerns. Feldstein interviewed on Reuters TV noted despite the recent improvement in the economy but there are still risks of another slowdown. Feldstein expects positive growth in the third quarter but said we could start see another economic downturn into the beginning of 2010. The impact of the stimulus will not last forever. Rising unemployment, weak consumer spending and tight credit conditions remain major headwinds to economic growth.Â
China's economy slows as stimulus is removed
The Financial Times reports that economic risks are rising in China as the stimulus plans are ending and the Wall Street Journal reports that China is facing a wave of bad loans. The Chinese economy is seen as key to the strength of the global recovery. Concern about slower growth in China may limit the current rally in global equity markets and the strength of the global recovery. China's economic outlook is uncertain as Chinese officials put a cap construction lending, restrict the expansion of steel production for next three years and the government plans to audit China's banks. The bank audits may further reduce lending activity in China. China's latest economic data for July indicated that while growth is moderating but the recovery remains on track to achieve the government's goal of 8% growth for the year. The Shanghai Index is 14% lower than the years high set on August 4th. The direction of the Shanghai Index is being closely monitored as a gauge for risk sentiment and the outlook for global growth. If the Shanghai Index resumes its slide it could hurt optimism about the global recovery.
Bernanke and Trichet pledge no exit from stimulus yet
The exit strategies and timing of these strategies will be key towards the global economic outlook. Trichet urges caution about EU recovery outlook. ECB President Trichet said that the road to recovery will be bumpy and he questioned how sustainable recovery is. Trichet said that the ECB would not rush to reverse emergency stimulus. Bernanke and Trichet are in agreement that central banks must continue to guard the global recovery against relapse. Bernanke says the US is on the verge recovery and prospect for growth is good. The Fed announced earlier in the month that they will gradually end bond purchases starting in October. The Fed is cautiously starting its exit strategy. Trichet and Bernanke do not want to encourage speculation that interest rates may be raised anytime soon. Tightening of policy too soon may choke off the recovery. The ECB and Fed are expected to err on the side of caution. Investors are counting on central banks to refrain from draining liquidity too soon.
Economic data will be key
Focus turns to this week's release of key US reports on home prices, consumer confidence, new home sales and GDP. The trade will be looking at these reports for confirmation that the US recession is ending. Assessing the outlook for the global recovery will emerge as the key focus for financial market trade. USD outlook is tied to strength of global recovery and the timing of the exit strategy from fiscal and monetary ease. The key risk to the global recovery is whether fiscal and monetary stimulus is withdrawn too soon raising new risks for the global recovery. At best the global economic recovery would be an even and this means that the rally in equities and the decline in the USD may soon slow.