Concerns Over Fiscal Sustainability Threaten Economic Recovery, Suggest More Market Turbulence
Rising concerns about fiscal sustainability even in AAA-rated countries such as the US and the UK threaten the global economic recovery and suggest market turbulence ahead. Those concerns are highlighted in a complimentary download of the Economist Intelligence Unit’s latest Global Economic Outlook.
Selected excerpts:
Markets for equities and other risky assets have recovered dramatically since their low points around March 2009. This partly reflects the fact that liquidity problems and distressed sales are no longer a widespread issue and risks envisaged earlier have not materialised. However, exceptionally loose monetary policy has also contributed to ample speculation in riskier assets.
Moreover, many investors seem to have been carried away by enthusiasm about the recovery, failing to recognise that the drivers of the recovery are short-lived or fragile and that imbalances persist. This means that evidence that the recovery will not be as sustained as currently priced by asset markets and the withdrawal of policy support will lead to substantial volatility.
Rising concerns about fiscal sustainability, particularly in the developed world, will contribute to further market turbulence, even if, as expected, Greece does not run into payment difficulties when its refinancing needs peak over the coming months. Almost all major economies have implemented costly fiscal stimulus and the economic downturn has led to a sharp fall in revenue in many economies.
Financial sector rescue measures have also contributed to additional strains on the public purse. There is little doubt that these measures were necessary, but there is a concern that governments will find it hard to reverse the upward trend in public debt. A default in Iceland or another small economy would raise risk premiums for a broad range of countries. But this would probably depress yields on Treasuries from core economies such as the US, even as US debt is continuing to increase.
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