The fall in US unemployment remains slow but with no clear deflationary threat the US Federal Reserve is in a quandary regarding the next steps in its monetary policy. John Authers, Long View columnist, asks Gavyn Davies, chairman of Fulcrum Asset Management, what Ben Bernanke, chairman of the Fed, is most likely to do next.
Risk assets rose slightly last week, and global equities are still trading within about 2 per cent of their highs for the year. The resilience of equities was slightly surprising in a week which saw both a disappointing set of US GDP data and a Fed policy statement which was on the hawkish side of expectations. Goldman Sachs’ economists commented that the US economy and financial markets are “moving into a tougher environment”, in which the economy is slowing and the Fed is shifting its policy reaction function in a less stimulative direction.
One reason why risk assets have remained firm recently, is that earnings in the latest company reporting season have once again been beating expectations in the US and the eurozone. According to Jan Loeys at JP Morgan, US corporate earnings per share for 2012 Q1 have come in 8 per cent higher than analysts’ expectations, while the drop in eurozone earnings has been 4 per cent less than feared. Clearly, corporate financial strength has been helping investment sentiment, but that would not persist for very long if the Fed really did change its tune on monetary policy. Read more
The minutes of the Federal Open Market Committee meeting on March 13 have surprised the markets. The committee seems to have shifted in a markedly more hawkish direction than was reflected in the statement issued after the meeting, and the bar to quantitative easing 3 now seems to be rather high. Perhaps we should have expected this, given the fact that speeches by chairman Ben Bernanke and Bill Dudley since the meeting had given no hint of any further easing. But the breadth of the committee’s shift away from easing was certainly not expected.
It is easy to find hawkish phrases in the minutes. The US Federal Reserve staff has not only upgraded its real gross domestic product projections, and increased its inflation forecasts, but has also reduced its estimate of the output gap. Only “a couple” of FOMC members saw any case for further easing, and then only if growth falters or inflation falls below target. There was even some discussion of changing the guidance on keeping short rates “exceptionally low” up to the end of 2014, a move which would really shock markets. Read more
As they meet today the Federal Reserve’s governors face a dilemma; with unemployment creeping lower while inflation rises, can they justify a third round of stimulative quantitative easing? Gavyn Davies, chairman of Fulcrum Asset Management, explains to Long View columnist John Authers that while the Fed is keen for QE3, it needs to bring inflation more under control first. (5m 27sec)
A large and important change is underway in global economic policy. This change will determine whether the developed economies can grow their way out of recession. Although the new strategy has been tried before by individual economies, this is the first time it has been adopted on such a global scale. If it fails, it is far from clear that policy-makers have a ready-made alternative plan waiting in the wings. Read more
The Bank of England meets on Thursday with expectations running high that the MPC will announce a further large dose of quantitative easing. Even if they pass this month, which seems possible, this is likely to be only a temporary postponement. Whenever it comes, the next move will be another bout of “plain vanilla” QE, involving the purchase of £50-75bn of government bonds, and taking the overall Bank of England holdings to over one third of the total stock of gilts in issue.
Meanwhile, the Fed is still debating whether to increase its holdings of long dated securities, and if so whether to focus once again on government debt, or to re-open its purchases of mortgages. Any further QE would be contentious on the FOMC, but there is probably still a majority in favour.
Central bankers, unlike many others, have not lost faith in the efficacy of QE. The vast majority of them not only believe that additional asset purchases can further reduce long term bond yields at a time of zero short term interest rates, but also that this can increase real GDP growth, compared with what otherwise would have occurred. Are they right? Read more
One of the great constants in the world economy in the past few decades has been the consistently strong growth in the US labour force. This has given American economic performance a demographic head start compared with other developed countries. Not only has it been the main factor ensuring that US GDP growth has remained well above that in Europe, it has also injected flexibility and dynamism into the US economy. But all of that is now at risk. The US labour force suddenly stopped growing in 2008, and has been falling slightly ever since.
As a result of this sudden disappearance of growth in the labour force, the unemployment rate has fallen by 1.5 percentage points in the past two years. But it is doubtful whether this represents a genuine tightening in the labour market. More likely, the underlying growth in the labour force has been disguised by the fact that potential workers have been discouraged from remaining in the labour market by the shortage of job opportunities. Without this shrinkage in the labour force, the unemployment rate would have risen to more than 11 per cent by now. It is urgent to fix this problem before the labour market atrophies, as it did in Europe in the 1980s. Read more
In the second half of 2011, the US economy appeared to buck the impact of the eurozone crisis, with American economic data surprising on the strong side in the final quarter of the year. But, as the new year begins, it seems improbable that economic activity in the US and the eurozone can remain so divergent for much longer.
Will the weakness in the eurozone eventually bring the US economy to its knees? Or will the greater resilience of the US win the day? The answer to these questions will determine whether the global economy will experience a double-dip recession in 2012.
The data released over the holiday period seem to be pointing in a more optimistic direction than markets have recognised. A year of above-trend growth certainly looks like a stretch in the present environment of fiscal tightening and global deleveraging. But the risks of a global double-dip recession appear to be receding, at least for now. Read more
The announcement of co-ordinated central bank action to boost foreign exchange swap lines on Wednesday has boosted market sentiment. The central banks have become extremely alarmed about the deterioration in the funding market for eurozone banks, and the consequent deleveraging of bank balance sheets which this is causing, and have decided to inject a great deal more liquidity into the system to bring this back under control. The injection of additional dollar liquidity which the Fed will undertake through its currency swaps with the ECB could potentially involve a very large increase in the Fed’s balance sheet, so it is worth understanding exactly what this initiative involves. Read more
American flag draped over the New York Stock Exchange. Getty Images
Such has been the intensity of the market’s focus on events in the eurozone in recent weeks that the performance of the American economy has barely merited any attention. At least, that has been the case in this blog, which usually tries to concentrate on the key events in global macro which are dominating market sentiment at any given time. So I have been looking across the Atlantic to check on what I might have missed.
In sharp contrast to the eurozone, the US economy has been performing better than was generally expected a couple of months ago, but it remains very vulnerable to the fiscal tightening which now seems likely next year, and to a worsening in the eurozone financial shock. This shock has not yet crossed the Atlantic with any force, but might do so before too long. Read more
Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.
He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.
Gavyn Davies is an active investor and may have financial interests and holdings in any of the topics about which he writes. The views expressed are solely those of Mr Davies and in no way reflect the views of Prisma Capital Partners LP, Fulcrum Asset Management LLP, their respective affiliates or representatives. This material is not intended to provide, and should not be relied upon for, investment advice or recommendations. Readers are urged to seek professional advice before making any investments.