WASHINGTON (Reuters) - Europe’s long shadow is tempering a burst of optimism that the United States can escape recession and China achieve a soft landing.
Deep concern persists that European leaders will fall short when they try to flesh out the details of how their rescue fund can tap sufficient resources to backstop Greece and to handle a potential government financing crisis in Italy or Spain.
Europe is looking to emerging economies to provide the extra financial firepower to strengthen the fund four- to five-fold, to about 1 trillion euros, a promise that could materialize at a Group of 20 summit in France on Thursday and Friday.
The response so far from China on strengthening the fund has been very cautious, and market experts want to see a fund with resources twice the size under discussion in Brussels. That has set the stage for possible unsettling disappointment in the days ahead.
“If the absolute amount is not enough, we will be back to the storms. The break in the clouds may only last a few hours,” said Ellen Zentner, senior U.S. economist at UBS.
Stronger-than-expected U.S. corporate earnings last week and third-quarter U.S. growth at a solid 2.5 percent, underpinned by surging business investment and a pick-up in consumer spending, have buoyed prospects for the global economy.
The drawdown in inventories in the third quarter also points to solid U.S. growth continuing through the end of the year.
Several Wall Street firms revised up their outlooks. JP Morgan raised its fourth-quarter economic growth forecast to 2.5 percent from 1 percent.
But talk to any economist or market strategist and every positive statement about the economic outlook is heavily hedged with warnings about what could yet go wrong.
The list is long.
Europe probably is already in recession; its politicians could fail to build a strong enough firewall in time to prevent financial contagion; and U.S. consumers are too heavily indebted to support strong growth next year.
Looming in the background are the U.S. budget deficit talks. Risks persist that lawmakers will reach stalemate by the end of the year, which would automatically trigger U.S. fiscal contraction at the start of 2012 if tax cuts and jobless benefits expire.
“The politics are improving in Europe, but the economic data is deteriorating and recession risks are rising. In the United States it is the exact opposite,” said Kurt Karl, senior vice president at Swiss Re American Holdings Corp.
Any of these factors could put the brakes on recovery.
The European Central Bank is widely expected to lay the foundation for an interest rate cut at its meeting on Thursday, citing the economic weakness in the 17-nation currency bloc. Euro zone manufacturing and services data due on Wednesday may confirm the tilt into recession seen in flash PMIs last week.
The ECB probably will also signal it will continue to purchase bonds issued by debt-heavy euro zone countries to promote financial stability, a move that gives leaders more time to finalize details of the debt plan.
Most analysts doubt Italian Mario Draghi will embark on bolder action at his first meeting as ECB president, although there is an outside chance for a rate cut.
Federal Reserve policymakers also are expected to tread cautiously at their meeting on Tuesday and Wednesday.
The improved U.S. data diminish the argument for further monetary easing, though Fed Chairman Ben Bernanke at his news conference on Wednesday is likely to repeat his disappointment at the pace of recovery and explore further options for supporting growth in face of the considerable risks ahead.
Several Fed policymakers have suggested the central bank needs to do more to support housing, the central problem for the U.S. economy.
Employment growth is stuck in a rut and consumers are digging into their savings to spend. As long as the American consumer, who drives 70 percent of all U.S. economic activity, is buried under a mountain of debt — much of it mortgage debt — and many houses remain worth less than the mortgage, consumer demand will remain weak and business hiring paltry.
Employment data on Friday is expected to show 95,000 new jobs outside the farm sector were added in October, a slight improvement from the prior month. But payroll growth since April has averaged only 72,000, less than one-third the pace needed to reduce the 9.1 percent jobless rate, and down from a 161,000 average rate in the prior seven months.
Income growth is negative once adjusted for inflation, and household debt loads at 133 percent of disposable income are too high to support much consumption.
“The underlying problem is to find where sustainable spending growth will come from,” said David Mann, U.S. economist for Standard Chartered.
Europe in recessionary territory and an impaired U.S. consumer also point to a deceleration in exports from China when its manufacturing index is released on Tuesday, rounding out a picture of a vulnerable world economy.
Editing by Dan Grebler