There is still an air of economic uncertainty in the US, but there is hope. Hope that this year will mark the start of a recovery. The struggle to reach that point places an emphasis on the string of economic indicators and the reality behind them. We know that the Fed is keeping a close watch and is considering its options should the economy show signs of strength later this year.
March FOMC Minutes
The latest minutes were released early to several high ranking officials and the joke goes that if they can't get an email right, what makes us so sure that they can get the timing of a QE exit correct. Nevertheless, the minutes for March were released to the public during the morning hours EST instead of the usual afternoon time. It showed the evident discourse among FOMC members about when the phase out of the controversial and much extended QE program (reaching a record $3.22 trillion) will occur. We get a feeling that the consensus is for later this year when some economists expect a pick-up in the US economy.
Even still, members said that if labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and eventually stop by year-end. There is still the possibility of returning to QE-lite because uncertainty still lingers, and the Fed might feel the need for continued support.
The debate over when to put a nail in the QE coffin is nothing new. The past few minutes have brought to light the concerning nature about balance sheet risk and the economy's ability to continue growth without the artificial push. The first mention of this was back in Q4 of 2012 which sparked an immediate stock market sell-off. Now, investors are aware of the ageing QE program, to the point where recent attention shifted to negative news from Cyprus which then caused a plunge in treasury yields.
The Breakdown
We can't ignore the healthy rise in equities. Some wonder if it is inspired by QE or just last minute bids on a general fear of missing out on some good gains. The fact is that QE has shifted asset allocation away from the usual safe-havens and stimulated a risk-on investment environment. But we have to take a step back and remember the fundamentals behind the recent low from early this year in which equities used as support for a rally. Stock market gains are not matching earnings and economic data, which suggests that a mix of sentiment and the quest for yield is the driving force. The stock market was bogged down with debt ceiling and fiscal cliff bickering at the start of 2013 which created a good buying opportunity. Technicals looked right and investors took advantage of the dip.
A deeper look into the economic fundamentals display some evidence of a transition to recovery. We see wealth gains mainly in the form of equities and a pick-up in housing construction and building activity. Consumers are still deleveraging which allows for spending. For example, refinancing could mean that savings are free to be allocated to more productive areas such as home improvement. A deeper look into the data gives us an understanding of how consumers are economizing during the economic transition.
Consumer debt has dropped to more comfortable levels, and credit can pick-up to reflect some confidence in the consumer's ability to borrow. However, the employment picture looks bleak. With a significant decline in labor force participation and a stagnant low-wage environment, there is little evidence to support a healthy labor market. Most of the activity is coming from the capital side of the growth equation. The fact is that most are under-employed and we are seeing households stick together - income sharing to phase out the negative in anticipation of a return to normalcy in which every member of the household is fully employed and self sufficient. Until we get there, a lot of the data might reflect only a half-truth.
We also have a demographic battle in which economic activity is missing the matriculation of first time buyers and the fresh labor pool of earners and spenders. The stark reality is that student debt is holding back the younger population resulting in higher defaults and the lack of entry level opportunity that is commensurate to the cost of study. Close attention to the Northeast housing and consumer market will be an important indicator to track this, as a great share of college graduates populate that region.
China marches back, but the West still looks ill
Good China trade and industrial data caught investors by surprise. There is a renewed sense of optimism in emerging markets overall. But some concerns over China's local debt problems and demographics keep the longer term outlook on a tightrope. The hope is that the new government will be quick to address these issues.
We will need full strength of the West for a clear sign of a global pick-up. Europe still looks weak with new sprouts of headline cases like Cyprus still in the mix.
The uncertainty is still there - look at the peso's fall against the greenback on Thursday as a signal that there is some concern about the ability of the US to boost the global economy. The Americas need the demand from the US, and LatAm markets can be an important indicator for foreseeable strength in terms of trade.
Long term view relies on current policy action
At some point, we will see sustained growth. Whether it starts later this year or rolls into 2014, there is evidence of transition and signs of hope. But the real question is how will we be able to keep the economic engine going.
Take a close look at the coming budget negotiations. Approach the issue with a clear mind and hear out both sides. Compromise on a long awaited budget will pave the way. We desperately need a framework to guide us through a recovery, or else we will get more of the same out of control spending and borrowing. There is doubt that whatever deal is reached, it will not be enough to address the serious fiscal deficit issue and economic folly that is inherently structural.
Immigration should be an important focus to keep the US as the most reasonable place to innovate. Innovation is part of the global market, and we must remain competitive. Higher education is taken up by more foreign students who will be at the helm of the growth. Look at Canada's latest plan for guidance.
Lastly, there is belief in the states. Despite underfunded pensions and liability short-falls, states have been busy strengthening their fiscal position. Most states are in a good cash position and the supply of municipal debt has declined. Investors are starting to see less risk, and the latest Census data shows an increase in state tax revenues. The revenue plans are highly strategic and take advantage of areas of productivity such as drilling out West. Some regions of the US are doing far better than most, and perhaps there's a good model out there for solid growth.
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