Nouriel Roubini: Brace for Market Correction Later This Year

Tax increases on wealthy Americans and reduced government spending will have a severe impact on economic growth in the United States this year, wiping out the positive effects of a revival in the housing market and cheaper energy, Nouriel Roubini told CNBC on Friday.

His comments come as investors eye the release of non farm payrolls data in the U.S for further clues on the health of the economy.

Speaking at the 2013 Ambrosetti Workshop, Roubini - the co-founder and chairman of Roubini Global Economics dubbed Dr Doom for his pessimistic forecasts - warned that despite some positive indicators for growth, a number of key issues would hold it back.

"These taxes, taxes for the rich are going to significantly reduce disposable income and retail sales have been a disaster. And there are already signals of consumption growth slowing down as well as the sequester and the fiscal drag this year will be 1.5 percent of GDP (gross domestic product) for an economy that was barely growing last year," he said.

The sequester refers to a series of spending cuts and tax increases which began to take effect last Friday aimed at reducing the budget deficit.

(Read More: The Pro-Growth Sequester?)

Despite encouraging signs of a renewed housing market, a revolution in shale gas which could result in cheaper energy and the effects of quantitative easing QE), U.S.growth would be "1.5 percent at best this year," Roubini said.

"Even without U.S politics [there would be a drag]. We've stolen growth from the future and now there needs to be payback for the mistakes made in the past.[The U.S.] needs to start some austerity," Roubini said.

Barclays revised its GDP forecast for the U.S. lower on Friday to incorporate the effect of the spending cuts. It now sees 1.5 percent growth in the second quarter of 2012 from a previous forecast of 2 percent. For the third and fourth quarter of 2013 it revised its forecast from 2.5 percent growth to 2 percent.

Roubini agreed that while equity markets were a positive, investors should brace for a shock in the latter half of the year as revenue begins to disappoint.

"It's positive because of the direct wealth effect and a signal that things might be improving but of course sometimes the stock market gives the wrong signal and I think the markets will be surprised by how much the U.S. will slow down even compared to last year and the second half of the year. The U.S. stock market could correct somehow," he said.

Jim O'Neill, the chairman of Goldman Sachs Asset Management, disagreed with Roubini's gloom over the U.S. economic recovery and his view of the equity markets.

"If we get further follow-through (on the U.S. non-farm payrolls on Friday) I can see people starting to get really excited about the cyclical momentum of the U.S. economy," he said.

"As chaotic as Washington seems, the way they're tightening fiscal policy is better than in Europe…Slowly but surely, the U.S. fiscal picture is improving. Here in Europe and the U.K., they're focusing too much on austerity," he said.

O'Neill, who is also attending the Ambrosetti Forum in Italy, said that the momentum in the U.S. equity market was solid.

"We have come a long way. I'm generally in the bullish camp so nothing happens in a straight line, the momentum behind the U.S. numbers is good. It's pretty interesting despite the so-called fiscal drag," O'Neill said. "Valuation wise, the U.S. market is nothing like as attractive as it was but the momentum from the numbers is there so what's going to cause it to top?"

Nouriel Roubini at the World Economic Forum in Davos, Switzerland.
Monika Flueckiger | World Economic Forum
Nouriel Roubini at the World Economic Forum in Davos, Switzerland.

Roubini also warned that the power of QE was now "becoming ineffective."

"The net wealth of the household has increased in the last quarter and it boosts confidence but it has less effect on the real economy. If you take away QE too fast there could be a significant back up in long rates and that would kill the recovery," he said.

Thursday saw the Dow reach new record highs after stocks finished higher for the third day in a row, up by 33.25 points to 14,329.49 largely on the back of an expected boost from nonfarm payrolls data later Friday.

(Read More: Kudlow: No Sequester Catastrophe )

Recent sessions have also seen the dollar continue to rise against other key currencies – it reached a 3-1/2 year high against the yen earlier Friday – as positive sentiment on the U.S. economy continues. Roubini added that its upward trajectory could still have some momentum left as other global currencies,sterling, the euro weaken in comparison and it's seen as a safety trade.

"As other countries continue aggressive QE and suffer from broader economic weakness (that implies) that the dollar can have some upside risk in a situation where the other currencies whether it's the yen, the British pound or the euro may be weakening," he added.