All the talk of letters a year ago made economists seem like characters on Sesame Street. Would the world see an L-shaped recovery or would it be more like a U? The most scary letter was W. But fears of a return to negative growth eased as economies stabilised and equities began their extraordinary rebound. Recently, however, cracks in Europe have been blamed for sending markets into a spin. US stocks have dropped by about one-tenth, month to date. Some European indices are down by almost double that. Investors are piling into bonds.
Is this sell-off, however, entirely Europe's fault? Perhaps markets are beginning to price in a double-dip recession. To be sure, most economic data around the world are still improving. Ironically, numbers are even ticking up in Portugal and Spain. Still, weak releases are beginning to appear. Yesterday in America, for example, jobless claims and the index of leading indicators were much worse than expected. April retail sales in the UK and Germany also disappointed.
It may seem like an overreaction to a few poor indicators. But markets tend to lead fundamentals and there are two other reasons to fear a double dip. The first is that, even with near-zero interest rates, most developed economies have only managed tepid recoveries. What happens when a few hundred basis points are added to borrowing costs? The second problem is circularity. Recent market panic could itself feed through to confidence and spending. With unemployment stubbornly high across Europe and the US – and housing moribund – it is easy to imagine shoppers pulling back. With consumption worth considerably more than half of output in many of the world's biggest economies, investors are right to fear the second half of 2010 being brought to them by the letter W.