Losing Faith in the Recovery

Americans are surely, albeit unwillingly, reconciling themselves to the reality that the economic recovery is faltering. The second-quarter results of many bellwethers are pushing stock prices down, clearly questioning the strength and sustainability of the recovery that only few short months ago seemed like a near certainty.

Leading the stampede towards the exit sign are equity investors. But they have not been the only ones in retreat. Crude oil slid as well, as the sentiment swelled that the demand for fossil fuel from major economies is declining in tandem with economies slowing down, too.

The U.S. dollar has also declined, particularly against the yen, to its lowest level this year. Finally, yields are plummeting, too. For example, the yield on the U.S. two-year note has dropped under three percent, because more and more investors perceive economic growth as nothing more than a mirage. In turn, falling yields are forcing the Fed to keep interest rates at super-low levels longer than anyone would have expected or even liked to.

Additionally, the Labor Department recently announced that the U.S. consumer prices index that excludes energy and food costs increased more than expected, which calmed fears of deflation, but only to an extent. However, what is keeping investors on edge is the consumer sentiment, which again seems to be in virtual freefall. For example, the Thomson Reuters/University of Michigan index gauging consumer sentiment has dropped to 66.5 so far in July, which is the lowest level it has hit since August of last year.

It is precisely this chronic negative sentiment that is threatening to strangle the recovery. The government has no more money to throw into the economy to keep the demand up, at least artificially, until the real demand kicks in. Alas, the real demand has never materialized and the market is now shaking in fear, because angry voters and stressed out bondholders are effectively putting politicians off new stimulus.

The problem is that, aside from more stimuli and interest rates being low, the government really has no more ammunition in its arsenal to fight a fall back into the recession and to keep the recovery going at any pace, even a snail’s pace if need be. And that prospect is fuelling tension in many markets, because no one can see where economic growth will come from.

The longer this impasse drags on, the drearier the economic prospects become. To put things into perspective, deflation is currently perceived as a relatively minor threat. However, as economic conditions deteriorate, deflation, for example, could become nothing short of a clear and present danger.