These are the views of Thomas Lam, group chief economist at OSK Group/DMG & Partners:
Notwithstanding the bounce in November consumer confidence on Tuesday, the tightening in broad financial market conditions has been continuing of late. The latter is mainly related to the ongoing sovereign risk irresolution in the euro zone and the growing probability of tail risks associated with significant financial and banking system exposures to the 17-member group.
The financial imprint combined with greater risks of U.S. fiscal tightening at the outset of 2012 should ensure that the downside risks to growth in subsequent quarters persist.
A simple regression exercise that takes into account broad financial market conditions and basic “adverse feedback loop” assumptions shows that if market conditions remain tight or tighten further in the current environment, real GDP growth could potentially downshift and slip into negative territory as early as summer 2012.
(An adverse feedback loop is defined as a situation whereby initial financial market strains weigh on the macro economy, and a weaker economy raises further uncertainty about the financial backdrop, which results in additional financial tightening, greater deterioration in growth, and so on.)
Our proprietary Financial Market Conditions Index, or FMCI, which exemplifies broad financial market conditions in the foregoing exercise, reached a peak around the second quarter of this year and trended lower in recent months. A negative smoothed growth rate of the FMCI is usually an indication of tight market conditions broadly. The FMCI dipped into negative territory in August 2011 and remained in sub-zero territory through November.