Global Economy: Grappling with the Fed and other uncertainties

3 minute read

By Alan Wheatley

LONDON (Reuters) – A clutch of surveys this week is likely to show the global economy slowly picking up even as new and old uncertainties combine to test the optimism of businesses and consumers alike.

Purchasing managers indexes (PMIs) for the euro zone, China and the United States are all forecast to climb further away from the boom-bust line of 50. Germany's closely watched IFO business sentiment index is also expected to show a gain.

Gross domestic product in the euro zone remains 3 percent below its 2008 peak and unemployment is at a record high, but the 17-member bloc is set to expand for the second quarter in a row after 18 months of contraction, according to Bert Colijn, an economist with the Conference Board in Brussels.

Even the construction industry, which crashed when the financial crisis struck, appears to be bottoming out.

"The outlook continues to improve for Europe in general," Colijn said. "The fact that we're seeing a momentum change at the moment is a positive signal."

Jim O'Neill, former chairman of Goldman Sachs Asset Management, said the PMIs of the entire Group of Seven advanced industrial countries were all rising quite significantly for the first time since 2008.

An exceptionally strong reading last week for the Philadelphia Federal Reserve's manufacturing survey also hinted that the global economy was stirring.

"It's quite conceivable that declining commodity prices are giving a big lift to real incomes," O'Neill said.


That's the good news.

The bad news is that the Fed, in deciding not to start scaling back its bond buying, has created new uncertainty by playing down the importance of the unemployment rate in isolation as a guide to its monetary policy.

In June, Fed Chairman Ben Bernanke said he expected to start withdrawing stimulus this year and end asset purchases by mid-2014, when the jobless rate was likely to be near 7 percent.

Last Wednesday, adopting a more discretionary stance, he emphasized that he had no fixed calendar in mind.

Although markets initially cheered the tapering reprieve, economists polled by Reuters said the Fed had failed to communicate its views clearly in advance.

Because the Bank of England has also tied its policy to hitting a precise unemployment target, the U.S. central bank's shift could have broader repercussions.

"The Fed's move is a major blow for the credibility of forward guidance," O'Neill said.

In standing pat, Bernanke said he needed more evidence of solid growth and fretted over a sharp tightening in financial conditions since he first flagged that tapering was on the way.

Robert Wescott, president of Keybridge Research in Washington, put more weight on a third reason Bernanke gave – a fast-approaching showdown in Washington over the 2014 budget and an increase in the federal debt ceiling.

"I do think at the margin that was the factor that tipped them into not acting," Wescott told a conference organized by Oxford Analytica, a consultancy.

If the Senate and House of Representatives fail to pass a funding bill, the government could shut down on October 1.

Although most Congress-watchers doubt it will come to that, Democrats and Republicans are digging in, ensuring a nervous end to the month for markets that could deflect attention from revised GDP, durable goods and housing data.


Another source of uncertainty is the shape of Germany's new government after Sunday's general election and what it will mean for Berlin's policy towards the euro.

Angela Merkel is expected to remain chancellor but she might need as long as two months to form a coalition.

If Merkel's Christian Democrats cannot continue to govern with the liberal Free Democrats but are forced into a coalition with the center-left Social Democrats, Germany may be more open to forging a banking union without an arduous treaty change, said Hartmut Mayer, a fellow in politics at Oxford University.

Mechanisms to supervise, bail out and close down banks at the euro zone level are critical to putting the single currency on a firmer foundation.

The Social Democrats would also be more open to the principle of euro zone debt mutualization as part of an ultimate solution to southern Europe's debt overhang, Mayer said.

"It would be the same chancellor but a different constellation and I think that makes a difference, he said.

(editing by Ron Askew)