A new report just released by Moody’s Capital Markets Research Group says that the recent volatility of equities markets in the U.S. -- along with other dreary economic news -- is having an unmistakably negative impact on the nation’s economy.

And they warn that things could get worse, saying that risk-averse investors should “prepare for the worst.

Moody’s Chief Economist John Lonski and Ben Garber, another Moody’s economist, write that the turbulence has “begun to paralyze business activity.”

Specifically, they point first to a plunge in the housing market index maintained by the National Association of Home Builders, which last week fell to its lowest level since early July 2010. Noting that mortgage rates have fallen to record lows, they write, “Heightened financial market volatility has prompted such an extraordinary upturn by cancellations of previously signed contracts to purchase a home that July’s existing home sales sank by 3.5% monthly.” 

The same consumer anxiety that is deterring people from buying a house is also affecting consumer spending in general, particularly, Lonski and Garber found, on big-ticket items.

But the impact of recent market turbulence has also been felt in the corporate world.  The Moody’s economists wrote, “Until financial markets stabilize, businesses are likely to postpone capital spending and freeze payrolls.”

Moody’s economist Gus Foucher explained to On Wall Street that while corporate managers might, during a period of robust economic growth, respond to a fall in share value by investing to boost profitability, “in a period when the growth outlook is weak, they are more likely to respond to a falling share price by trying to boost profitability by cutting costs.”

“Again,” write Lonski and Garber, “we are reminded of just how destructive financial market volatility can be to a fragile economic recovery.” They warn that the combination of continuing real estate deflation, a consumer pull-back and a pause in corporate investment and hiring “could crush a very fragile economic recovery.”

In addition to the feed-back loop of a turbulent equities market, Lonski and Garber warn about the impact of the debt crisis facing the Euro zone in Europe. They wrote that a resolution of Europe’s sovereign debt issues is “critically important” to achieving any stabilization of global financial markets.”

Lonski and Garber note that any potential QE3 stimulus program by the Federal Reserve would likely be much less successful than were either of the prior quantitative easing efforts, given that 10-year treasuries have fallen to a yield of 2.10%.

“Global financial stability,” they write, “might be better served by first resolving Europe’s sovereign debt issues, once and for all.”



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