Election results in the United States and troublesome economic data from the euro zone are sparking fears of a global slump.
After an initially favourable response to President Barack Obama's re-election Tuesday, investors concluded that Washington's fiscal crisis could worsen because the vote did nothing to resolve deep political divisions. Investors fled riskier assets for the relative safety of U.S. Treasuries, as worsening economic news out of Europe heightened the gloom.
The Dow Jones industrial average plunged nearly 313 points, its biggest one-day decline this year, and the broader Standard & Poor's 500 index posted its worst day since June. Oil futures fell nearly 5 per cent, the steepest drop in 11 months, which hit Canadian stocks and slammed the loonie.
Markets typically welcome status-quo elections. But the results of Tuesday's U.S. vote, which left Democrats in control of the Senate and Republicans retaining their majority in the House of Representatives, suggest it will be harder to reach a budget compromise in time to prevent automatic spending cuts and tax increases from taking effect in January.
Amounting to more than $600-billion (U.S.) worth of austerity, this aptly named fiscal cliff has the potential to drive the still fragile economy into recession in the first half of 2013 and trigger a global slump, unless policy makers reach a deal to delay or cancel the measures.
"It hits the economy where it's most vulnerable, which is the consumer," said Russ Koesterich, chief investment strategist with BlackRock Inc.'s iShares unit. People already suffering from weak income growth can ill-afford to absorb the extra tax hit, which would force them to reduce spending.
Even if the lame-duck Congress reaches a deal to postpone the fiscal reckoning, it will not keep the ravaged euro zone from sinking deeper in economic quicksand. The 17-country region will expand by a mere 0.1 per cent next year, the European Commission reported Wednesday. The worsening outlook for Germany and the region's other economic powers will make it tougher for Greece and the other crisis-battered members of the currency union to climb out of their deep economic holes.
The gloomy assessment came just hours ahead of a crucial vote on new austerity measures in the Greek parliament, which passed despite mounting public opposition – including a two-day general strike in the public sector – to further wage and pension cuts. The EC's previous forecast was for 2013 euro zone growth of 1 per cent. It expects the region to contract by 0.4 per cent this year.
The flagging German economy is expected to expand by only 0.8 per cent next year, down from the previous forecast of 1.7 per cent, providing more evidence that Europe's strongest economy is not robust enough to shield itself from the troubles in Italy, Spain, Greece and Portugal. Economic activity is slowing "across the board, as contagion fears hit output in the core economies," said Michael Hewson, senior market analyst at CMC Markets in London.
The revised official growth forecasts came a day after data showed that German factory orders fell a steep 3.3 per cent in September. On Wednesday, Germany released another set of grim numbers that showed a 1.8-per-cent decline in industrial production, month on month. Some economists now think the German economy is headed for a contraction.
"The German decoupling from the rest of the euro zone has come to an end," ING Groep economist Carsten Brzeski said in a note. "Strong trading ties with non-euro-zone countries had shielded the economy against the euro crisis. Now, with the global economy cooling in the second half of the year, this immunity is quickly fading away."