Uncertainty Undermining the Global Economic Recovery

The International Monetary Fund (IMF) said yesterday (Thursday) that the global economic recovery is losing steam because uncertainty in financial markets is keeping businesses and consumers from investing in future growth.

In a revision to its World Economic Outlook released yesterday in Hong Kong, the IMF said worldwide economic expansion will decline to 4.3% next year from 2010's 4.6% pace.  The forecast for 2010 was revised upwards by 0.4 percentage points to reflect faster-than-anticipated growth earlier this year.

However, "downside risks have risen sharply," the IMF warned, referring to European governments' debt problems and volatility in financial markets.

While Canada and the United States are leading developed economies out of the worst recession since World War II, European-area countries may need additional government actions to boost confidence in their banks, the fund said.

Meanwhile, growth in developing countries like India, China and Brazil is slowing, but they still run the risk of overheating, and could soon see problematic levels of inflation.  By contrast, rich countries are having difficulty maintaining modest economic growth amid concerns about a possible double-dip recession and deflation.

"The overarching policy challenge is to restore financial- market confidence without choking the recovery. The new forecasts hinge on implementation of policies to rebuild confidence and stability, particularly in the euro area." the IMF report said. "Recent turbulence in financial markets -- reflecting a drop in confidence about fiscal sustainability, policy responses, and future growth prospects -- has cast a cloud over the outlook."

The uncertainty has put a chill on investing by important players in the financial markets, including hedge funds.

Reeling from the worst second-quarter performance in a decade, hedge funds have scaled back trading as they struggle to figure out where markets are headed amid vicious crosscurrents in stock, commodities and bond markets, according to brokers and managers interviewed by Bloomberg News.

Prime brokers that service hedge funds, such as Credit Suisse Group AG (NYSE ADR: CS) and JPMorgan Chase & Co. (NYSE: JPM), say managers are borrowing less money and sitting on more cash, Bloomberg reported. Credit Suisse's hedge-fund clients were holding 24% of their assets in cash in June, compared with 19% three months earlier, according to the Zurich-based bank's prime brokerage unit.

Hedge-fund managers, who oversee $1.67 trillion in assets, are hesitant to put money on the table as they are being rocked by a wide range of conflicting political and economic forces. Low interest rates and stimulus programs in Europe and the United States, global regulatory reform, and slowing growth prospects in China and Asia are among the issues in play.

"There's a degree of being frozen in the headlights, of not knowing what sectors to emphasize, of what securities to emphasize," Tim Ghriskey, chief investment officer of Solaris Asset Management LLC, a firm in Bedford Hills, New York with $2 billion in hedge funds and conventional stock funds, told Bloomberg.

Any pull back by hedge funds and other investors takes liquidity out of the financial system that could, in turn, have a negative effect on investment in developing countries.

Fiscal woes in advanced economies may curtail the flow of capital to emerging markets, Olivier Blanchard, the IMF's chief economist, said at a press briefing in Hong Kong. Blanchard said the reversal will prove "temporary" in the aftermath of the European crisis, with a resumption of flows over time.

The IMF expects U.S. growth to slip to 2.9% next year from 3.3% in 2010. And it sees only a modest 1.3% improvement for Eurozone economies in 2011, compared with 1% this year.

JPMorgan chief economist Bruce Kasman puts the chances of a recession in either the United States or globally at less than 15%, The Wall Street Journal reported. But the Institute of International Finance, a bankers' association, as well as JPMorgan and IHS Global Insight (NYSE: IHS) have recently issued forecasts projecting steeper 2011 declines than the IMF. All three blamed the decline on a cutback in government stimulus spending next year, slower growth in manufacturing, fiscal consolidation in Europe, and falling consumer confidence in the United States and Europe.

"The sense of optimism we had for a strong recovery has waned," Ronald DeFeo, chief executive of Terex Corp. (NYSE: TEX) a Westport, Conn., construction-equipment exporter told The Wall Street Journal.  "There's a sense of reality that rebuilding [global demand] will take many years."

News & Related Story Links:

• The Wall Street Journal:
  IMF Sees Rising Risks Slowing Pace of World Recovery
• Bloomberg:
  IMF Raises 2010 Growth Estimate, Sees Recovery Risk
• Bloomberg:
  Hedge Funds 'Frozen in Headlights' Scale Back Trading
• Money Morning:
  Money Morning Midyear Forecast: The U.S. Economy is Headed For a Second-Half Slowdown