The rich world appears stuck in a vicious cycle: subpar growth begets market volatility that then dampens confidence and damages prospects for further economic expansion.
U.S. consumer sentiment plunged to its lowest level since 1980 in early August, a drop due in part to shaken nerves following a swoon in stock markets around the world.
The same applies to Europe, where efforts to reduce government debt have had the perverse effect of stifling economic growth, thereby making deficits costlier to sustain.
Eurozone industrial output posted a surprise decline in June, boding poorly for second-quarter gross domestic product, which is due Tuesday and forecast to have expanded just 0.3 percent compared with the first quarter.
At the same time, concerns that until recently had been relegated to the so-called European periphery — countries like Greece, Ireland and Portugal — are now knocking at the door of major economies like France and Italy.
This has prompted a spike in bank borrowing costs that is raising fears of a reprisal of the late 2008 credit crunch.
"It is hard not to get a sense of deja vu," said Maneesh Deshpande, head of U.S. equity derivatives strategy at Barclays Capital, in a conference call addressing market volatility.
"Once unthinkable things have happened, such as the U.S. losing its AAA rating. Investors are literally feeling the earth shifting under their feet, you just don't know what else you thought of as rock solid, might turn out to be untrue."
A Reuters poll last week suggested economists are no longer certain the euro zone's recovery can be maintained, with a few expecting near stagnation until at least 2013.
In a way, erratic financial markets are a reflection of what many analysts see as a central contradiction of global economic policy — a predilection for spending cuts at a time when stimulus is what is most needed.
Europe is the perfect example. Many of its nations are faced with high unemployment but also elevated debt burdens. With short-term investor fears driving a focus on the latter, joblessness has been ignored.
That omission is now coming back to haunt markets as analysts sense the possibility of a renewed period of economic contraction in either the United States, Europe or both.
"Fiscal tightening in an environment where unemployment decreases only slowly could erode consumption growth," said Laurence Boone, European economist at Bank of America-Merrill Lynch.
The same worries apply to the United States. Growth in the world's largest economy slowed to a trickle in the first half, and recent data suggest a long-heralded second-half rebound will be meeker than first thought. Unemployment has also remained stuck near 9 percent, raising speculation the Federal Reserve might have to be even more aggressive in its monetary policy in order to revive the labor market.
Inflation data from the Labor Department due Thursday will give policymakers a sense of how much wiggle room they have. U.S. consumer prices are forecast to have risen 0.2 percent in July. Prices outside food and energy, the U.S. central bank's preferred way of looking at inflation, are forecast to rise 1.7 percent on an annualized basis — just around the Fed's comfort range, but too high for many policymakers to allow for additional easing.
Which takes us back to the markets. A key reason equities have rebounded from a nearly 20 percent slump was that the Fed, apart from making an unprecedented promise to keep rates near zero for another two years, said it was exploring other options for monetary support.
If the central bank fails to deliver a new dose of cash to a hungry market, it could lead to another market slide that could again imperil the recovery.
"In an environment in which market participants are concerned about the debt crisis in Europe, fiscal problems in the U.S. and signs of a broader global economic slump, every additional risk factor might be the straw that breaks the camel's back," said Harm Bandholz, chief U.S. economist at UniCredit Research.
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