Source: JP Morgan / beforeitsnews.
Investor appetite for risk assets returned in the third quarter. Risk assets were broadly supported by a shift in the global economy towards recovery. The euro zone economy broke out of its longest ever recession after six quarters of negative growth and data suggests the economy will continue to grow. Meanwhile, uncertainty over the tapering of the US Federal Reserve’s (the Fed’s) quantitative easing (QE) programme proved to be unfounded and fears over another crisis in emerging markets faded.
The euro zone took its first tentative step towards recovery, with the economy expanding 0.3% quarter on quarter in the three months to June. Growth was strongest in the core countries of Germany and France and the pace of economic contraction in the peripheral economies slowed. Economic data from the single currency bloc continues to improve. Consumer and business sentiment has also risen to multi-year highs. Even though the risk of a complete collapse of the euro zone has greatly diminished, there remains a degree of political instability within the periphery. Crucially, the impacts on markets from recent political flare ups have largely been isolated and bond yields remained in check. This is very much in contrast to how the situation may have transpired 18-24 months ago, and is largely down to the European Central Bank cementing its role as backstop for the region.
Whilst the euro zone is on the road to recovery, the situation in the US is reaching a head with The Federal Reserve being correct in their fears about Washington’s ability to overcome the fiscal deadlock. The US congress failed to agree a plan to fund the government by the end of September, leading to a shutdown for the first time in nearly two decades.
The greater concern, however, is the approaching debt ceiling. Politicians must agree to raise the amount that the US government is allowed to borrow by mid-October to prevent the US from running out of funds to meet its obligations. Markets will be increasingly volatile as the deadline approaches and investors will be hoping for a repeat of 2011 when the political parties reached an eleventh hour deal to raise the borrowing limit, although this would only been seen as a temporary fix of the debt issue and would not defuse the fundamental conundrum of the U.S. fiscal deficit or improve repayment ability in the long-term.
This paints a negative outlook for the United States, as the Federal Reserve continues to inject dollars into the market through quantitative easing policies, eroding the value of the outstanding debt, hurting ‘creditors’ interests in the process and putting the U.S. Government credit rating on “rating watch negative” for a downgrade to their rating, which would put them several notches below the top rating and on par with Brazil, Israel and Panama, among others.