Turbulence on US financial markets which is spreading to other regions may well be an indication of an impending worldwide economic slowdown, two people familiar with the matter said in separate interviews on Friday.
The sell-off, which started last week on the New York Stock Exchange and led The Dow Jones Index on Thursday to drop by over 1,000 points for the second time in a week, is related to the expected phasing out of the Fed’s accommodative monetary policy, said financial consultant Elena Constantinou.
The Dow closed 4.2 per cent lower on Thursday compared with Wednesday. On Friday, Chinese shares fell by an average 4 per cent, while European markets fell for the ninth time in ten days.
Due to the time lag in the transmission of the impact of policy decisions in the US to Europe the European economy could be affected as early as late 2019, said Constantinou, founder and director of the Nicosia-based RIM Think Acute Consulting Ltd. That means economies with vulnerabilities, such as Cyprus with its over-indebted public and private sector, should take proactive measures to mitigate the impact of increased borrowing costs, she added.
Due to the expected impact of Brexit on the euro area’s economy, the European Central Bank (ECB) will not be too aggressive while phasing out its low-interest-rate policy, and will first halve its asset purchases to €30 billion a month before communicating its intention to proceed with interest rates hikes, Constantinou said.
“As a (Cypriot) finance minister I would try to take advantage of the current low interest rates to repay more expensive debt and resort to reforms, including privatisations,” she continued. Privatisations are seen as a way for the economy improve its competitiveness and the government to reduce public debt, which last year was projected to have fallen below the 100-per cent mark for the first time since 2013.
Constantinou warned that the government needs a long-term plan to encourage the reduction of the economy’s excessive reliance on certain opportunistic economic activities and offer incentives to the primary and secondary sector.
Bank of Cyprus’ chief economist Ioannis Tirkides said that US financial woes may have been sparked by more than the long overdue ‘correction’ he initially saw on Tuesday, the day after the Dow fell by 1,175 points, the largest drop in a single day ever.
Three days later, Tirkides saw there may be “deeper causes than a mere correction,” including concern about the outcome of the Italian election causing more political uncertainty in Europe.
Still, the underlying long-term trends remained positive despite concerns about regional geopolitical tensions, the impact of the latest tax reform in the US expected to lead to larger fiscal shortfalls and fears of trade wars, he said three days later.
“This year will not be as calm as the years before it,” he added. The announced phasing out of the Fed’s accommodating monetary policy will lead to a reduction in central bank balance sheets and to ‘sustainably higher’ levels of interest rates.
“This is going to cause a change in the direction of money flows, this time out of equities,” he said. “More selling may be forthcoming, but it will not necessarily mean that there will be a recession in the global economy any time soon”.
Constantinou added that all these ‘risks existed last year and will continue to exist this year’.
“However, throughout 2017, and in January, markets were complacent about the prospects of the global economy, as growth was accelerating,” she said.