Why Early Dec Will Be Financial Markets Last Hurrah! Global Economy to Crash
Nov 29, 2011
Part of this article was originally published to C3X clients on 28 Nov 2011 early Asia trading time and discussed in the C3X live trading room, on Nov 18 2011 when the S&P was at 1160 and AUD/USD below 0.9688, EURUSD at 1.3230 and USDCAD at 1.0480. Markets have already moved in the direction of trends and trading calls that we have published since then.
On fundamental side, we believe that the world is about to crash to a crisis that we may not have seen in our life times. Two of the world largest importers of world trade, China and India are now nearly 200 bps of their peak growth rates with both countries slowing sinking into a political quagmire.
In the euro zone, to everyone utter surprise, Germany is becoming the crux of the problem. Macro economic slowdown and credit markets starting to question the very ability of Germany to be the corner stone of EU bailout. The CDS flew of the handle to 120 from under 100 levels though since then have calmed. But it was a stark reminder to Berlin that “Do not take the bond markets for granted”.
As the crisis has spread over the last six months into the larger peripherals, the need for fiscal consolidation from large euro area member states has increased. Austerity in these larger member states such, as Italy and France, clearly weighs more on euro area economic prospects than does the austerity in smaller countries. Six months ago, we were already predicting a significant tightening of the euro area fiscal stance in 2012.
The failure of the EU authorities to find a solution to the sovereign debt crisis means the downside risks are materializing. The ECB will step in as a temporary buyer of Italian and Spanish bonds but treaty changes and fiscal union are coming our way in 2012. But without the compensating moves on the political front, markets will fear this as politically unsustainable.
The trouble is, we fear the impact of fiscal tightening on broader economic activity is itself increasing, that is, the fiscal multiplier is growing. We think this for two reasons. First, the crisis is having a materially greater impact on the bank credit channel. Second, the austerity has been insufficient to inject confidence back into markets, with the danger that it loops back into the economy with no tangible benefits seen in which case a greater level of austerity will be demanded which will then shrink growth even further.