Optimism has seized stock markets in the past month on the back of better economic data in the United States and a late-summer lull in the euro crisis. Market volatility is at its lowest level in years.BofA’s top economist Ethan Harris says investors shouldn’t be fooled in a pretty downbeat note to clients – he thinks the U.S. economy is “in the eye of the storm” right now.
Here is what Harris sees on the horizon:
We remain very concerned about the outlook. In our view, the markets have been lulled to sleep by a temporary remission in negative macro news. The better US data probably reflects a combination of the usual random variation and weather distortions. Mild weather boosted the winter statistics, there was a payback in the spring and now the data are settling into a weak trend…
We believe the Euro zone crisis is far from over. At this stage the policy pattern for Europe is well established: (1) A funding problem in one of the peripheral countries arises; (2) policy makers engage in brinkmanship with the core demanding austerity and the periphery demanding bailout; (3) the markets start to melt down; (4) policy makers do just enough to satisfy the markets, but not cure the underlying problem. There is nothing merry about this go around. Over time it undercuts the foundations of the Euro zone. The economy steadily slides into recession, populist parties grow in strength and the markets become increasingly fragile. For the US and the rest of the world this means ongoing collateral damage, primarily through confidence and capital markets.
The worst of the US fiscal crisis also lies ahead. Note that in the uncertainty shock literature, the impact of the shock grows exponentially as the day of reckoning approaches. The cliff is slowly working its way into corporate thinking. The real test will come in the fourth quarter when the cliff will be just months away and the incentive to delay spending and investment decisions will peak. The timing is tough, but we would expect some weakening in the September data and very soft numbers in the October to January period. We are keeping a close eye on corporate commentary, confidence surveys, indicators of hiring and capital goods orders.
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