This article originally appeared at elEconomista.es, an online Spanish business news website. Click here for the original version of this article, in Spanish.After the latest 4Q GDP review, the US economy is now dealing with the double shock of the Japanese earthquake aftermath and Middle East crisis, both of which could continue putting pressure on oil prices.
Under these circumstances, John Lonski, Managing Director and Chief Economist of Moody’s Capital Markets Research Group, proposed an extreme scenario that could trigger a correction of 10 to 20 per cent in equities and possibly force the Federal Reserve to consider a QE3.
“I think the leading candidate for triggering this kind of adverse event would be the instability of the Middle East driving energy costs sharply higher,” he said while pointing out that a spike in the price of gasoline from $3.66 a gallon to over $4 a gallon could create real risks in the US economy and consumer sentiment.
Lonski said that the March payroll numbers set to be released Friday, April 1, could see an increase of 190,000 jobs.
“If payrolls continue to grow by at least 180,000 jobs per month on average through May, there’s every reason to believe that the Fed will allow QE2 to expire,” he said.
According to the Moody’s chief economist, even if QE2 comes to an end in June, the Fed may continue to purchase US treasuries securities in order to replace holdings that are maturing.
“I think that the Fed will be cautious of not allowing a contraction of its holdings of treasuries that would put any unwanted pressure on interest rates,” Lonski said.
On the other hand, quantitative easing could be extended in the event that the US economy slows considerably, especially if we see a “pronounced deceleration in economic activity from now until the end of June,” Lonski observed.
What could happen for a sharp downward spiral to happen?. Aside from what´s going on in the Middle East, Lonski also presented the possibility that that policymakers in Europe could decide to say “enough is enough” to bailouts and perhaps call for a restructuring.
“We can remember how much damage the decision on the part of US government did to the world economy and financial markets when they decided not to bailout Lehman Brothers,” Lonski pointed out.
Finally, the third cause of an extreme correction in financial markets could come from Japan. “Poisonous radiation that spreads from Japan to other areas could potentially damage neighbouring economies,” Lonski said.