Two Steps Forward, One Step BackApril 7, 2015
The long anticipated first rate hike by the Federal Reserve once again appears to be on hold after a disappointingly weak March employment report. The culprit this time is the strong dollar, which has blunted the manufacturing recovery that spurred real GDP growth in mid-2014 to a 4.8 percent annualized gain. Growth in the first quarter of 2015 is now expected to rise at less than a 1 percent annual rate. In our view, this see-saw pattern illustrates that the US economy remains bound by the incremental tightening of fiscal, regulatory and exchange rate policies. The executive, legislative and even judicial branches (ACA) of our government are all placing limitations on the private sector via regulations, taxes and limits on spending—while our foreign competitors are trying to steal growth away via devaluation and regulatory protectionism. The end of quantitative easing last October represents the Federal Reserve’s own contribution toward more restrictive policy. Though they remain on the path to higher interest rates, their trigger of higher inflation continues to be delayed by the pass through of declining energy prices and still slack labor markets. As other agents continue to hobble growth, the Federal Reserve is likely to remain on the sidelines.
The US economy remains in a two step forward, one step back mode as every surge in growth during this long, but slow, expansion has been curtailed by a tightening of some policy. Initially, the Greek crisis in 2010 and Japanese tsunami in 2011 limited the impact of the 2009 stimulus. The debt default discussion and sequestration limited growth later in 2011. A renewal of Greek contagion problems in 2012 required even more US monetary stimulus. In January 2013, the end of the 2 percent FICA holiday hit consumers. The discussion about the end of QE pushed long term rates 135 basis point higher from April 2013 to January 2014. By then, a renewed threat of government shutdown and the impact of the start-up of Obamacare pushed growth negative in the first quarter of 2014. With strong growth in late 2014, long rates again rose sharply and the dollar soared as competitors around the world devalued via expansion of their own quantitative easing.
The common thread through all these episodes has been that despite record high profits as a share of GDP, businesses have been reticent to expand investment. As a result, it is hard to translate the surges in growth into an accelerating spiral—but slowdowns also don’t fall into collapse, as there are few workers in risky (investment) operations. Rather, surges in spending translate into market pressure on interest rates or the currency, or lead regulators to crack down, or spur Congress to remove fiscal stimulus. With no investment impulse to offset these drags, the economy reverts to the mean of moderate growth. After a slump in Q1 of 2015, US real GDP will be back near 3 percent compared to a year ago—just slightly above the consensus for potential growth. Though we expect growth to sustain that pace for the rest of in 2015, there is not much upward pressure on inflation when the GDP gap is closing so slowly. Bottom line, until savers collectively become greater risk takers via increased capital spending, interest rates are likely to remain quite low. The latest rounds of QE here and abroad have only redistributed risk. Equity investors continue to increase leverage to boost yields, while bond pools swell with more cautious fixed income investors even at near zero interest rates.
The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.