August 9th, 2011
05:43 PM GMT
London (CNN) – The unprecedented downgrade of the U.S. debt rating Friday triggered mass sell-offs in equity markets around the world, with $2.5 trillion wiped off global stocks yesterday following last week’s losses.
While markets are steadying, the dramatic slump and unhealthy economic data has raised questions over the risk of another U.S. recession – one which could tumble into Europe.
The debt crises on either side on Atlantic have also thrown into sharp contrast the different strategies employed to deal with financial meltdowns.
The U.S. used stimulus; Europe turned to austerity. Both strategies are struggling to stave off economic pain.
As the U.S. was downgraded, the European Central Bank was preparing to reactivate its bond buying program, this time for Italy and Spain, in an attempt to stabilize the eurozone markets.
The ECB move comes after austerity programs introduced in the eurozone’s troubled economies failed to calm investors.
The ECB’s program kicked off this week but it is not regarded as long-term safety net, given the EUR660 billion debt burden for Italy and Spain until the end of 2012.
Tobias Blattner, of Daiwa Capital Markets, says that load means the two countries simply can’t rely on the ECB for support. The most likely medium-term option to inject confidence into the eurozone bond markets is a combination of market interventions by the ECB and later the European Financial Stability Facility, Europe’s bail-out fund, he says.
Meanwhile, as the ECB strategy comes under scrutiny, focus has turned to the U.S. Federal Reserve amid speculation it could provide further stimulus. On Tuesday, it said it would keep rates low through until 2013 in response to a slowdown in the U.S. recovery.
But does stimulus or austerity work? According to Elisabeth Afseth, fixed income strategist of Evolution Securities, both approaches are failing. “It’s hard to see how to get out of it...it’s a frightening prospect,” she says.
The U.S. officially exited its 18-month recession - defined by two successive quarters of negative growth - in June 2009. Just under a year ago, economists surveyed by CNNMoney put the chances of a double dip recession at 25%.
Post downgrade, economists including Nouriel Roubini, of Roubini Global Economics, are getting more bearish.
Roubini told CNN's Piers Morgan the chance of another recession is now at least 50%, in the U.S. and periphery of the eurozone. He pointed to the loss of equity wealth, falling value of homes, a lack of job creation and flat consumption as being contributors to another recession. Further, he said, there is a lack of policy tools to jumpstart the economy.
Any recession in the U.S. would impact to Europe, with Germany, the export led-economy driving the eurozone through its own economic trauma, likely to be hard hit.
Others are less bearish. Societe Generale’s chief European economist James Nixon is not yet picking a recession, although he expects three to five years of mediocre growth in the U.S. and Europe.
Afseth also expects a long period of sluggish growth. Either way, “it’s hard to see a positive outlook,” she says.
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