Is economic improvement a false dawn?

Global data turned up, on the whole, in early 2012, leading some to question whether this is finally the year of the self-sustained recovery – one that doesn't have to be continually nudged along with fiscal stimulus or quantitative easing. However, we heard the same conversations at the start of 2010 and 2011 – yet by the second half of those years jubilation had turned to disappointment.

Why did the green shoots die as soon as autumn approached? In our view it all comes down to real income growth. The fundamental problem in the Western economies is that real incomes have been stagnant for five years, making the required deleveraging a long and arduous process.

For real incomes to rise materially we need a combination of employment growth, wage growth and stable or falling household costs, such as fuel prices. It was hoped the corporate sector would kick-start this process: if firms could be nurtured (or coerced) into using their cash flow to create jobs, this could help households feel better about life and spend more, which in turn makes firms more willing to employ, and so on. No more need for stimulus; the economy would find its own virtuous cycle.

The fundamental problem in the Western economies is that real incomes have been stagnant for five years.

US payroll data and the Institute of Supply Management surveys in early 2012 provided signs that the USA could be moving in the right direction. But even if this is sustained in the short term, can it be maintained through the year? In the first quarter of 2011, the pace of job creation was just as strong, but by the middle of the year, it had again slowed to a trickle.

A pickup in oil prices in early 2011 undoubtedly played some role in denting final demand and hiring intentions. One hopes this will not be repeated this year, although the situation in Iran is troubling. But the other key factor was the political deadlock around reducing government debt in both the USA and the eurozone. This issue is still unresolved and seems likely to return to the market's attention before too long.

As the US election approaches, the country's fiscal problems will be at the forefront of political deadlock between the Republicans and Democrats. One key battle will be over whether the 'temporary' tax cuts enacted by Bush in 2001 and 2003 will be extended again. They are scheduled to expire at the end of 2012.

In the eurozone, the three-year long-term refinancing operation has clearly helped commercial bank liquidity and appears to have eased government liquidity constraints, with Italy and Spain auctioning debt at lower interest rates. But the highly indebted governments must now demonstrate that it is politically feasible to deliver the austerity being demanded of them, and allow the private sector to continue growing.

Past political deadlock played a major role in reducing household and business sentiment in both Europe and the USA.

This is where the indicators don't provide much comfort. The peripheral eurozone economies are still contracting and the pace of job shedding increasing. Moreover, credit conditions are only just starting to tighten, threatening the ability of small- and medium-sized firms to expand and create jobs.

Even if we are positively surprised by the behaviour of politicians in the USA and the eurozone, and if the USA manages to maintain the pace of job growth, the scale of the employment challenge ahead is still huge. We have seen 'jobless' recoveries before – but not one as bad as this. US job insecurity is high, so it's no wonder workers aren't asking for more pay: individual real income gains are still some way off.

There are some green shoots evident in the global economy. But we have been here before. Past political deadlock played a major role in reducing household and business sentiment in both Europe and the USA, putting paid to the recovery by the second half. We remain concerned 2012 will see another repeat performance from politicians – and therefore from economies and markets. Déjà vu again.

This report must be read with the disclosures, analyst certifications and the disclaimer.