Among the bedrock assumptions for 2014 among macro-economists, two are central: first, that the real GDP growth rate in the US will accelerate as the fiscal squeeze abates, and, second, that the Federal Reserve is now on “auto pilot”, and will taper its asset purchases by about $10bn per meeting until they disappear entirely before year end. Last week, the December jobs data challenged the comfortable assumption of accelerating GDP growth, and the publication of the latest FOMC minutes provided some interesting new insight into divisions within the Fed.
Most analysts have responded to these events by concluding that nothing much has really changed. That is probably right, for now. Although the employment report was something of a nightmare, involving both a very weak gain of only 74,000 in nonfarm payroll employment and another disconcerting drop of 0.2 per cent in the participation rate, it is only a single month’s reading, amid a snap of very cold weather. It will be brushed aside.
Longer term, the combination of only moderate employment growth with a shrinking labour supply is a persistent phenomenon that is likely to challenge the FOMC increasingly as 2014 progresses. The Committee seems fairly united for now around the announced path for tapering, but there are significant divisions in members’ underlying economic analysis that are likely to be laid bare before too long. Read more
Janet Yellen is likely to be confirmed by the Senate as the next Fed Chair on Monday, and Ben Bernanke delivered an initial version of his own personal history in an address to the American Economic Association on Friday.
Typically objective and analytic, it won him a standing ovation (watch it here ) that accurately reflects what the majority of the academic economics profession thinks of the man and the public servant. Despite the highly controversial nature of his actions, they view him as one of their own. He has risen to greater importance in public office than any previous member of the academic economics profession, including John Maynard Keynes.
The history books will no doubt focus on the Fed’s role in the great upheavals of the age. The outline verdict is already clear for some of this.
The Fed clearly underestimated the impact of the housing bubble on the economy, and failed in its regulatory duties from 2006-08; its reaction to the financial panic in 2008-09 was exemplary; its role in cleaning up the US banking system in 2009 was important and far-sighted; and its balance sheet expansion from 2010-13 was more aggressive than most other central banks, with both good and also some not-so-good effects. (See this blog for a lengthy assessment of QE.)
According to the “great person” view of history, Mr Bernanke will be the individual who gets most of the blame and plaudits for all these developments. The buck stopped on his desk. Yet he was only one actor among dozens in Washington. As a believer in the “great events” view of history, I have been trying to identify the areas in which Ben Bernanke personally made a difference that others might not have made. Read more
As we enter 2014, the five-year bull market in developed market equities remains in full swing. Recently, I argued that equities now look overvalued, but not egregiously so, and that the future of the bull market could depend on when the level of global GDP started to bump up against supply side constraints, forcing a genuine tightening in global monetary conditions.
Today, this blog offers a year end assessment of three crucial issues that relate to this: the supply side in the US; China’s attempt to control its credit bubble; and the ECB’s belief that there is no deflation threat in the euro area. At least one of these questions is likely to be the defining macro issue of 2014 and beyond. Read more
The long farewell to quantitative easing, one of the most remarkable experiments in the history of macroeconomic policy, starts now. In the wake of the strong US employment data in recent months, the Federal Reserve finally announced that it will taper its asset purchases from January onwards. The Fed’s balance sheet will stabilise in 2014, but will not begin to decline for several more years.
Variously described as the saviour of the global economy, totally irrelevant, a drug for the financial system or the harbinger of future inflation, QE is still controversial and insufficiently understood. Macro-economists are destined to be studying its effects for decades to come. Here are some early reflections. Read more
For all type of investors, one question for 2014 dominates all others: can the great bull market in risk assets, especially in US equities, continue for another year? John Authers points out that there is an unusually strong consensus in analysts’ forecasts for next year, with almost everyone expecting stronger global GDP growth, dovish central banks and further rises in equity markets. As John says, this “cozy consensus” borders on complacency.
Investor psychology usually reflects the recent past. The year just ending has seen the best performance by US equities in the past four decades, with the single exception of the calendar year 1995. The word “best” in this case does not refer to the highest absolute return, but to the highest Sharpe ratio, which measures the risk-adjusted return.
Strongly positive returns, with very low volatility, is a dream scenario for investors, especially since the stellar performance of 2013 comes on top of several previous years in which equities also rose markedly, though with much greater volatility than seen this year. So is all this simply too good to last? Read more
In recent months, inflation has again reared its head as a problem in the developed economies. But this is not because it is too high. In most countries, headline CPI inflation has been falling significantly since the end of 2011, and it has now dropped to less than 1 per cent in both the US and the euro area.
Furthermore, the pervasive decline in headline inflation has been accompanied by a similar decline in core inflation rates, which are also hovering at worryingly low levels in most countries. In fact, out of the 25 developed economies that publish regular data on Haver Analytics, only Iceland is currently experiencing an inflation rate that could be considered markedly too high by any of these measures. Read more
When George Osborne, the UK chancellor of the exchequer, stands up to deliver his Autumn Statement on Thursday, he will be able to talk about good economic news for the first time since 2010. The speed of recovery in the economy in the past six months has been little short of astonishing. This will certainly have persuaded the Office for Budget Responsibility to increase its gross domestic product growth forecast for 2014, causing an automatic reduction in government deficit and debt projections.
The vicious circle linking low growth and high budget deficits, so prominent in Mr Osborne’s first three years, has been transformed into a virtuous circle — for now, at least. It will take a Herculean effort of self-control for Mr Osborne to resist claiming: “Austerity works”.
The acceleration in UK GDP growth during 2013 has far out-stripped that in any other leading economy, following a period of several successive years in which the opposite was the case. According to “nowcasts” for economic activity (see graph below), UK growth has been running at above 5 per cent annualised for several months, compared to about 1.5 per cent at the start of the year. For a while, sceptics argued that these nowcasts were being over-influenced by buoyant survey data, but there is now evidence from hard economic data that the take-off in activity is genuine. Read more
International investors often complain that they have a hard time understanding the actions of the People’s Bank of China. The PBOC still seems to pride itself on the inscrutable nature of its policy pronouncements, rather in the style of the Fed until the mid 1990s. In order to judge what the Chinese monetary authorities are doing, it is necessary to watch their actions more than their words, and even then there is plenty of room for misinterpretation. As in other areas of Chinese public administration, power resides in secrecy.
The fact that Chinese monetary policy can seem obscure to outside observers does nothing to diminish its importance. In fact, the ongoing attempt to deflate the 2010-13 credit bubble in China is more important for the global economy than the Fed’s tapering plan, or the ECB’s thinking on negative deposit rates. A collision is developing between a progressive tightening in monetary conditions, and the inflationary psychology of the housing and land markets. No-one can be certain how this will end. Read more
Mark Carney’s announcements today about the UK housing market represent the first blast from a major country of a new policy weapon that is increasingly available to the global central banks, a weapon known as macro prudential regulation. Because this weapon is seen as an alternative to raising short rates, not as a prelude to raising them, the Carney intervention should logically under-pin the lower-for-longer path for short rates discussed in his evidence to the Treasury Select Committee earlier this week. Mr Carney has turned more hawkish today, but not more hawkish about interest rates or sterling.
The Carney announcement will represent an important restraint on the UK housing market, which was showing distinct signs of getting too ebullient in the south east of the country. By acting early, and using methods that are distinct from the short term interest rate, this action may well make the economic recovery in the UK more durable than otherwise, though it may slow down some parts of the consumer sector in the immediate future. Read more
The past week has been another important one for Fed watchers, a group which nowadays seems to include almost every active investor in the financial markets. Following the decision of the Senate on Thursday to ban filibustering on Presidential nominations to many important federal posts, it has been suggested by Morgan Stanley that Ms Yellen might take up her position as Chair in time for the next meeting of the FOMC on 17-18 December, two meetings earlier than previously expected.
Furthermore, according to Neil Irwin, President Obama will now find it easier to appoint at least two new monetary doves to support Ms Yellen on the Board of Governors next year. This will offset what might otherwise have been a shift towards hawkishness on the FOMC, since regional Presidents Fisher and Plosser (both hawks) are rotating into voting status, and the unannounced new President of the Cleveland Fed may turn out to be “on the hawkish end”, according to J.P. Morgan.
These personnel changes will create their own uncertainty. But, in addition, the Fed’s monetary strategy is clearly in a state of flux, with its approach to tapering having developed markedly in recent weeks. A new “separation principle” seems to be emerging, and it explains why the FOMC seems eager to begin winding down its asset purchases in the near future, while relying even more heavily than before on “lower for longer” guidance on forward short rates. This could have important ramifications for markets. Read more