Monday, August 29, 2011
Bernanke acknowledged that the recovery was proving to be slower than expected and that the temporary factors he has alluded to previously account “for only a portion of the economic weakness that we have observed. Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the committee has marked down its outlook for the likely pace of growth over coming quarters.”
He made it clear, without going into any new detail, that the Fed has tools at its disposal and will use them, should conditions warrant: “The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability.”
The price stability context is an important one. Conditions in 2011 are significantly different to those that prevailed in 2010. Last year as QE2, was being considered, core inflation was below 1% and falling. In 2011 it is over 2% (PCE deflator) and rising. That makes QE3 a significantly different proposition to QE2. Throughout the speech every reference Bernanke makes to employing further stimulus is qualified that any action needs to be in the context of price stability. That does not rule QE3 out, but neither is it a done deal.
With regard to the longer run prospects for the economy, we agree with everything Bernanke says. He makes the point that building a stronger recovery in the US is not just a monetary policy issue: “...most of the economic policies that support robust economic growth in the long run are outside the province of the central bank”. A stronger more sustainable economic recovery needs a broad policy response. No brainer.
With regard to fiscal policy he states “...US fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable, or preferably, declining over time”. However, he stresses the importance of a balanced approach: “Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery.”
As far as we are concerned, Bernanke said all the right things. Importantly, while he did not offer up new stimulus at the weekend, he is obviously prepared to go there if needed. It is interesting in that regard that the September FOMC meeting has been extended from its scheduled one day to two. But there were equally important messages for policymakers in his speech. In short, monetary policy can’t do this alone and there is considerable work still ahead in building an enduring recovery.
Wednesday, August 24, 2011
It seems to us, however, that conditions in 2011 are somewhat different to 2010. In the third quarter of 2010 the core personal consumption expenditure (PCE) deflator was running at an annual rate of less that 1% and falling. At that point the risk was a period of debilitating deflation. In 2011, the risk of deflation has receded significantly: core PCE is at 2.1%. Some would argue it has been eliminated, unless you believe the US economy is headed for another deep and protracted recession (not our view).
In the 2010 speech, Bernanke was at pains to point out that before deciding to implement QE2, the Fed would undertake a rigorous cost/benefit analysis before implementing. They obviously came out on the side of the benefits being greater than the costs. But it has not been clear to me exactly what the benefits have been, especially with regard to the real economy. Until recently it appeared the Fed simply increased banking system reserves which ended up as excess reserves on bank balance sheets.
More recently, however, it is notable that US money supply growth has spiked higher. Is this a sign that those higher bank reserves are becoming increased money supply? If that higher money supply becomes loan growth, that is one reason to be somewhat optimistic about the outlook. We will be watching this closely.
So what should we expect from Jackson Hole this week? Not a lot would be my guess. At various times the Fed has flagged other options open to it including cutting the interest rate on excess reserves and extending the maturities of their Treasury holding by selling short-dated maturities to buy longer-dated bonds. They could also commit to a timeframe for keeping the Feds balance sheet unchanged as they did at the last FOMC for interest rates.
The flagging of QE3 would be premature at this point, although he will highlight it as an option for later if needed. I have no doubt the Fed would go down that path were they to think it necessary, it’s just not necessary now. They haven’t come this far to throw in the towel.
There’s still one comment from a recent Bernanke speech that keeps coming back to (haunt?) me. As QE2 was coming to an end in June he said: “Monetary policy is not a panacea.” That's a really big sentence in the context of his speech this weekend. It seems to me he will point out that there is only so much monetary policy can do. Interest rates are low and can’t go much lower and banks have considerable capacity to lend. The building of the new US economy requires a broader policy response and it is just going to take time.
Wednesday, August 17, 2011
We had previously expected the weak point in the Europe slowdown to be in the third quarter of the year: Europe appears to be running 2-3 months behind the trend in the US. We now expect to see a similar result for Q3 GDP i.e. a small positive result, before a modest rebound towards the end of the year.
This result highlights again the importance of striking the right between fiscal austerity and supporting economic growth. Ultimately countries with high structural budget deficits and unsustainable debt levels need to grow their way out of the problem.
It also highlights the risk we talked about earlier as the ECB embarked on what we believed was a premature monetary policy tightening. Expect the ECB to revise down their growth forecasts and for the hawkish monetary policy rhetoric to cease. we don't expect them to ease again, at this point, but neither do they need to tighten further.
On the political front, the French and German leaders have concluded a meeting at which they discussed policy options for long-term stability of the Euro area. The most important outcome was their post-meeting unanimity, most likely sensing that last week’s “crisis of confidence” was more about politics than anything else.
They have again talked of obligating all Euro area countries to make balanced budgets a constitutional requirement. We’ve been here before, and we think it’s a necessary step, but we need to start seeing some detail. In particular – what happens when a country breaks the rules? The idea of a financial transactions tax has also re-emerged. More on that another day.
They appeared to pour cold water on the concept of Euro bonds, but all they really did was signal there needs to be considerable alignment of fiscal policy before that can happen. That makes sense to us.
Monday, August 15, 2011
Partial activity indicators have been signally a relatively rapid recovery in output following the earthquake. After a sharp decline of over 15% following the earthquake, industrial production has risen in three consecutive months and is now only around 5% below its immediate pre-quake level. Machinery orders have also been picking up faster than expected.
Given the strength of recent activity indicators we expect Japan to return to growth in the third quarter. Export growth is likely to be tempered by the recent strength in the Yen and modest global growth. Power disruptions could still impact on activity as we move into summer, the peak period for energy consumption in Japan. On the plus side, earthquake rebuilding activity should be starting to provide some positive momentum from the fourth quarter.
Friday, August 12, 2011
The US and Europe growth stories have not changed: both are in fragile debt-constrained recoveries. Both public and private debt levels are too high, and bringing that debt back to more sustainable levels would keep growth constrained for a number of years. We have also previously talked about how their recoveries would tend to be non-linear; that is, periods of relatively good data would, from time-to-time, be followed by periods of weak data.
What we are seeing now is another one of those weak patches. However, rather than being caused by transitory factors, it’s another soft patch which has been exacerbated by these factors. They include global supply chain disruptions following the Japan earthquake, disruptions from bad weather and high commodity prices acting effectively as a tax on household incomes. As a result US Q2 GDP data was soft. Expectations are that in Europe, where the slowdown is running at bit behind that of the US, Q3 GDP will print close to zero.
While recent and near-term growth looks softer, we have not changed our medium-term view of continued weak but positive growth. In America that view is, as it always has been, based on strong (non-financial sector) corporate balance sheets and the fact those corporates are looking to invest. We have always looked to business investment and exports to be the strongest components of US GDP growth in the early stages of this recovery. The concern is if recent uncertainty and volatility is prolonged, it could knock confidence to the extent that investment and hiring plans get delayed. We will be watching developments on that front closely.
There are good news growth stories out there too. China growth looks solid. We continue to expect a soft landing there with GDP growth of 9% this year and perhaps a tad lower next year. Japan is also recovering faster than expected.
It’s timely to be reminded of one of our long-term themes: growth in developed markets will be hard work over the next few years while it will be stronger and more sustainable in emerging markets. That was the reason we shifted our global equity managers to the MSCI All Country World Index, or ACWI, which includes an exposure to emerging markets. The weighting to these countries will rise automatically over-time as the balance of global growth shifts to what we, at least currently (!!!), call emerging markets.
The US downgrade didn’t tell us anything we didn’t know. The US is in a weak growth environment and fiscal policy settings are unsustainable. We continue to believe the downgrade by Standard and Poor’s was aimed mostly at the politicians who are unable to articulate a medium-term plan for fiscal consolidation. The political challenges are immense, but the risks of not doing this are even greater.
If politicians fail to develop such a plan, they will continue to be forced by market pressures into increasingly ad-hoc and short-term measures that threaten the important balance between fiscal consolidation and supporting economic growth. After this week I can now type that sentence blind-folded! Countries facing the debt sustainability issue need to grow their way out of it. All other options are unpalatable, but they are most certainly avoidable.
One risk of the US downgrade is that other AAA countries seek to speed up their fiscal austerity plans in order to preserve their own ratings. This would be counterproductive. It’s not the speed of achieving fiscal sustainability, it’s about having a credible plan to get there.
We have warned for some time that as the focus turned to fiscal and debt issues in the US, we would inevitably see an increase in the US risk premium. Any impact of the S&P decision on that front has been well and truly swamped by heightened concerns about the growth outlook and the still strong “safe haven” status of US Treasuries. The Fed reinforced the low-interest rate case this week by signalling it is likely to keep the current level of exceptionally low interest rates in place until mid-2013.
But we also see it as symptomatic of the changing world order. America has lost its AAA credit rating. We have seen a structurally weakening in the US dollar and a structurally stronger Chinese Yuan. That’s important for the required rebalancing in global growth. The G20 has supplanted the G7 as the lead group of countries that will determine the future look and feel of the global monetary system. These are all signs of the shifting balance of economic (and eventually political?) power in the world. All fascinating.
Europe debt crisis
The US needs to learn from the recent experience of Europe. Without a long-term plan, things can get very untidy. The latest developments and concerns have been mostly to do with Italy. Again, we think the concern is overdone.
The primary problem in Italy is weak growth: GDP growth has averaged less than 1% per annum since the start of the recovery. The other important point is that Italy’s finances are actually not that bad. Italy has committed to a balanced budget by 2013 (one-year earlier than previously) and is already running a primary budget surplus. Much of the concern has been around its high sovereign debt (120% of GDP), but its net external debt is only around 20%. That compares to 100% for Greece and 17% for America.
The good news is that decisions taken at the Euro area summit on July 21 did take important steps forward. The strengthening of the EFSF and the ECB’s subsequent decision to reopen its Securities Market Program were positive. But all this is doing is buying time for politicians to work out a long-term solution for the management of funding for Euro area governments. We believe this must include a high degree of fiscal co-ordination or some degree of fiscal union. This would probably lead, in time, to the issuance of Euro Bonds which could end up rivalling Treasuries for safe haven status, assuming they are designed well.
There is still plenty of work to do and in the meantime markets will fret. The concern is that if Italy does fall over (unlikely), the European Financial Stability Fund is not big enough to bail it out.
In summary, for us, not a lot has changed on the economic or political front over the last few days. This is NOT a re-run of 2008. We started the week committed to our neutral growth/income position in the multi-sector funds, and that’s where we end the week. We will keep you informed when that changes! Have a restful weekend.
Wednesday, August 10, 2011
It was important, however, that the Fed didn’t buy-in to the panic currently gripping equity markets and do more than they needed to do. There were some expectations in the market that QE3 was going to get announced today. The wise words of Homer Simpson come to mind - “Doh!”
To go down that step, the Fed needs to believe their dual mandates of full employment and price stability are at threat. At this point the FOMC “expects a somewhat slower pace of recovery over coming quarters…and anticipates that the unemployment rate will decline only gradually…” On inflation, the FOMC “anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate…” Those views, with which we concur, are not consistent with another round of quantitative easing. However, we have no doubt the Fed will go down the QE3 path should that need arise, but that’s a debate for later.
What they have done is put a time-frame on their previous comments around the expected “extended period” for exceptionally low interest rates: “The Committee currently anticipates that economic conditions…are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” This has led to a further rally in the short-end of the US yield curve from what were already expensive levels. It’s incredible that only a few short months ago markets were pricing in a rise in fed funds later this year. Anything to say to that Homer?
Monday, August 8, 2011
As part of the Euro-zone summit agreement last month, the European Financial Stability Facility (EFSF) was given power to buy government bonds in the secondary market if the ECB thought it was warranted and member states agreed. That role for the EFSF is still to be ratified by individual member parliaments, but the agreement was meant to spur the ECB into action in the interim, should it be required.
The ECB intervened in Irish and Portuguese debt markets last week, but not Italian and Spanish markets. That was a key source of a source of negative market sentiment last week. Over the weekend France and Germany have pledged to get the required legislation through their respective parliaments allowing the EFSF to start purchasing bonds, probably by October.
For their part, Italy and Spain have committed to new deficit-reduction measures. In particular, Italy has committed to bringing forward its balanced budget by one year to 2013. At best that was the right answer to the wrong question. It’s not so much about WHEN fiscal consolidation is achieved as it is about the credibility of the plan. There is still a paucity of detail around exactly HOW Italy intends balancing its budget.
The bigger problem is the EFSF is not big enough to cope with a default by Italy and Spain. That concern will remain until either there is greater credibility around individual member fiscal consolidation plans and/or there is a “Shock and Awe” type strategy that significantly boosts the size of the EFSF. Neither Germany nor France thinks that is necessary…yet. Another possibility is the issuance and conversion of Euro-area national debts into Euro Bonds, but that seems likely to be a debate for a different time.
As we mentioned this morning (see below), one of the concerns following the US downgrade was that it may suggest to some governments they should implement even harsher fiscal austerity plans to maintain their ratings. One country that comes immediately to mind in that regard is France. A downgrade to France would have the complicating factor of undermining credibility in the EFSF by reducing the AAA rating on one of the important guarantees.
All harsher austerity achieves is damage to growth prospects. This raises further questions about fiscal sustainability rather than answering them. Sorry to sound like a worn record, but getting the right balance between fiscal austerity and supporting growth is critical.
The new part of the equation was, as we mused following the debt ceiling debate of recent weeks, the failure of politicians to develop, articulate and ultimately implement a credible long-term plan to achieve fiscal sustainability. Fiscal consolidation then becomes a series of short term measures that makes it difficult to achieve the important balance of achieving fiscal sustainability and supporting economic growth. S&P’s action at the weekend was as much an indictment on the political process, than anything else. Perhaps in time we will look back on this as being a wake-up call?
Given the economic fundamentals of the US are well-known they are already, to a large degree, reflected in asset prices. The US Dollar is weak and much of that weakness is structural, reflecting the drop in relative living standards that is the primary legacy of Global Financial Crisis.
Bond yields are low reflecting the low growth/benign inflation outlook and (still) safe-haven status of US Treasuries. If you’re going to sell Treasuries today, what are you going to buy? It has been our medium-term view, however, that US bond yields would rise over time as investors became increasingly focussed on fiscal issues. That would be reflective of a rising US risk premium. S&P’s actions may well front-load some of that premium.
On the other hand (don’t you love it when economist’s say that?) there may be a downward impact on yields as investors take this opportunity to reassess the US growth outlook. The consensus view on medium-term US growth is still too high in our opinion. We think trend growth in the US is now about 2.5% and developments over the weekend haven’t changed that view.
None of that stops a likely knee-jerk reaction to the downgrade as markets progressively open this week. Equity markets have already dropped significant in recent days and this won’t do anything to help sentiment. What’s cheap can always get cheaper.
One of the interesting things to watch in the days, weeks or months ahead will be how other countries, especially those who are still AAA-rated, respond. It could be that some decide to take a harder austerity line to protect their rating. While that sounds admirable, it is the wrong way to think about it. It’s not about how fast fiscal consolidation occurs, it’s all about having a plan that is credible and gives markets confidence that there is commitment to achieve it. That is all that’s really missing in the US and Europe and should be an easy fix. Should be….
Thursday, August 4, 2011
It’s important at times like this to keep your head and stay true to investment philosophy and process. Here’s how we are thinking about things right here right now.
The major disappointment for us in the recent data has been the downward revisions to previous US GDP growth estimates. Those revisions have shaved around 1 percentage point off annual GDP growth. We are unlikely to gain that 1 percent back: I can’t raise my growth forecasts for the rest of the year. That means we have to take the lower growth on the chin and cut our year-end US GDP forecast from 2.5% to 1.5%. At this point I have left 2012 at 2.5%.
The good news is the weaker growth explains one conundrum of recent US data – weak jobs growth. July payrolls data is out this weekend. The consensus view is for jobs growth of 75,000 (according to Bloomberg), but after the recent trot of news, you’d have to think the risk is to the downside.
As we have discussed before, we concur with the view that there are transitory elements to the recent weakness in US activity data. But there is more to it than just the supply chain disruptions following the Japan earthquake, weather disruptions and high commodity prices: broad-based softness in jobs growth is the clearest indicator of that. Perhaps a better way to describe the current situation is that the US is going through another soft patch, much like it did last year, but this time it has been exacerbated by a number of transitory factors.
What is also different to last year is the synchronicity element: we are seeing weaker growth in Europe at the same time. Even in Germany, the powerhouse of Europe and the primary reason for the ECB’s tightening strategy, industrial production is slowing. That may still have something to do with the tail-end of the inventory cycle but it’s more likely that German corporates are reassessing the Europe/global growth environment. Expect the ECB to abandon its tightening strategy and perhaps to embark on some quantitative easing of its own.
While the risk of a sustained slowdown and even a return to recession in the US and Europe has increased, that is not (yet) our central scenario. But it does raise the chances of QE3. The debt ceiling debate in the US has confirmed to the market that fiscal policy no longer a tool to support aggregate demand. We have, to date, been somewhat lukewarm on the prospects of a further round of quantitative easing, but if the Fed were to take the view that recent economic weakness is becoming entrenched, we have no doubt they will implement a further QE program. The good news is that non-financial corporate America is in good heart. Strong business investment is a necessary precursor to stronger future growth.
Counterbalancing the weak trans-Atlantic story, Japan is recovering well and we are increasingly confident of a well-engineered soft landing in China. That assumes that China authorities make better use of the exchange rate in the fight against inflation. We continue to believe inflation is close to peaking in China. Furthermore, there is still robust economic growth across the other key emerging economies. Emerging markets will continue to be the key source of global demand in the years ahead. That argument becomes somewhat redundant in the short-term if the US and Europe fall back into recession.
It is not just growth that is worrying markets at the moment. There is still a major systemic risk overhang from the debt crisis in Europe. Greece, Portugal and Ireland cannot access debt markets. Spain, Italy and Belgium can, but with rising risk premiums. The July 21 agreement bought more time for Greece and finally started to deal with the issue of solvency, although not to the extent that markets have parked concerns about disorderly default.
Italy should prove to be more resilient than the smaller countries. It has a well managed budget, they have a high debt maturity (7.1 years) and the banks are solid. But a 10-year bond yield above 6% is not sustainable. Italy’s weakness is its poor growth performance. We also think Spain’s fundamentals are sound. Its main weakness is a negative net investment position (-87% of GDP).
The July agreement gave a broader role to the European Financial Stability Facility (EFSF) by allowing direct intervention in government bond markets and the ability to lend to governments needing to recapitalise their banking systems. But the limited size of the EFSF cannot prevent the spread of contagion to Italy. Should crisis hit Italy, we are back to watching the politicians demonstrate their commitment to the Euro-area.
In summary, recent market activity has predominantly been a re-rating of near-term US GDP growth, exacerbated by a concurrent slowdown in Europe. The debt ceiling debate-debacle hasn’t helped but America is not the key debt risk (yet). That still remains predominantly a Europe story. On the positive side Japan is recovering and there continues to be strong growth in the key emerging economies.
The most important point of all, however, is that equity markets are cheap. But as we know, what is cheap can become cheaper. We continue to be focussed on the medium-term and remain happy with our current portfolio positions which is neutral on a growth/income split. Obviously we are thinking hard about the future, as we have the whole way through, and will alert you to any changes in thinking or positions.
Wednesday, August 3, 2011
Let’s remember what the GFC was all about: for many developed economies it was (and still is) a correction following many years of spending and living beyond our means. Over that period unsustainable fiscal, particularly entitlement, polices were introduced. Pre GFC, there were a number of years before these issues needed to be confronted. The GFC and its aftermath which included, in many countries, lower potential growth, higher debt levels and large structural budget deficits, has closed up the timeframe for dealing with those issues to NOW.
I know it’s a long-time ago, but those of you with good memories will recall that when we first started thinking about stimulus “exit strategies” a couple of years ago, we made the point that Governments needed to articulate credible medium-term plans to achieve fiscal sustainability. Failure to do so would result in markets dictating the course of events.
That would result in ad-hoc short-term piece-meal solutions to what are essentially big long-term problems. That’s just what we have been witnessing in Europe and now America: the failure of politicians to develop and then articulate credible medium term plans for fiscal consolidation.
That approach looses an important element of balance. If politicians developed long-term plans, it would be easier to strike the appropriate balance between supporting economic growth and getting ones fiscal house in order. Fiscal consolidation doesn’t need to happen today. Markets just need to know today how it’s going to happen in the future. That could be a (credible) 10-year plan.
That would require politicians to openly acknowledge that spending cuts need to be made and/or taxes need to be raised. But politicians don’t like taking things off people. Developed world debt issues aren’t going away any time soon.
Tuesday, August 2, 2011
No matter which way you look at it, this is an awful result. It comes hot on the heels of weaker than expected Q2 GDP data which was accompanied by around 1 percentage point of downward revisions to historical growth estimates. Europe is going through a similar soft patch.
Much has been made of the apparent transitory reasons for some of the recent weakness: supply-chain disruptions on the back of the Japan earthquake in particular. But as we have commented previously, there is more to it than that.
There are a couple of straws to clutch. It’s good news that the Inventories index also dipped below 50 to 49.3. It is possible to construct a not unreasonable scenario that recent demand has been met out of inventories but firms have delayed pushing the button on new orders in the face of uncertainty around the raising of the US debt ceiling.
Other good news was the Prices Paid index dropped 9 points from 68.0 to 59.0. Some relief is coming thru on the commodity price front which is good for profitability and investment and hiring. Combine that with the fact that business investment was still strong in the otherwise weak GDP data that bodes well for a pick-up in growth later. It’s also good news that both the imports and exports indices were up.
Monday, August 1, 2011
In New Zealand, the Reserve Bank signalled they would soon remove the 0.5% insurance easing they delivered following the February Canterbury earthquake. That being the case we have brought forward our expected December tightening of 0.5% to September. We have pencilled in 50bp increases for every MPS after that until June next year, which will see the OCR at 4.5% by then. That track will be somewhat dependent on the exchange rate, but given economic growth and emerging inflation pressures, that degree of tightening appears appropriate at this point. We still believe that may be enough interest rate tightening, given the “de-stimulus” work fiscal policy will be doing over the period ahead.
India raised interest rates by 0.5% for a second time in succession. We have commented before that India is behind the curve in the inflation fight. India was overheating prior to the GFC and seemed to go straight back there afterwards. After a string of 25bp hikes the RBI finally accepted they were behind the problem and stepped the tightening up a notch. Good on them. Even in this post GFC world, the best contribution monetary policy can make to building sustainable growth is to keep inflation expectations in check. And after so long worrying about deflation, it’s nice to see at least some central banks battling inflation.
Australia inflation surprised on the upside in the June quarter. The team in Sydney has looked closely at the data and after stripping out higher fruit and petro price and a range of government related charges, they think inflation is running at a pretty benign 2.5%. Consequently the view is the RBA should keep rates on hold this week in light of increased global uncertainty, the fragile nature of household demand and the stronger Australian dollar which is doing a lot of the RBA’s work for it.
In Europe, both business and consumer confidence faltered. The optimistic view of this is that Japanese earthquake related supply chains disruptions are impacting the manufacturing sector, just a few months later than elsewhere. It could also be the continuing debt issue is impacting confidence as well. Our concern is that as with the US, there is a little more to it. Time will tell. This is yet another reason to keep a cautious approach to growth assets. It also highlights the risky tightening strategy currently being employed by the ECB.
The compromise appears to be a two-tranche increase in the debt ceiling totalling $2.4 trillion. The first tranche of around $1 trillion spending cuts would be agreed as part of the deal, with the detail of the second tranche to be agreed later. There appears to be no revenue initiatives in the proposal, making the package more challenging for the Democrats to agree to than the Republicans.
There is still a lot of work to do to get this through. This feels a lot like 2008 waiting for the Troubled Assets Rescue Program (TARP) to get approved. TARP eventually got through, but not without plenty of drama and market volatility. Once agreement on a deal is reached, legislation cannot be passed in time to meet the August 2 deadline. The Senate will use short-term measures to extend the debt-ceiling but this can only buy days rather than weeks or months.
Right here, right now we are actually more concerned about US economic growth than the politics of the debt ceiling. Second quarter GDP growth came in at weaker than expected 1.3% (seasonally adjusted annual rate or saar). Revisions to historical data as a result of annual benchmarking knocked a total of 1% off previous growth estimates.
We have been somewhat downbeat on the US growth outlook right from the start of the recovery. Since the recovery started, the average quarterly growth rate has been 2.5%, well short of a “normal” recovery which would typically see growth rates of around 4%. The theory was that household and finance sector deleveraging initially, then followed by government deleveraging, would keep growth subdued for many years, but the last six months in the US have been weaker than expected. We agree with the Fed’s assessment that some of this current weakness is transitory (Japan earthquake supply disruptions and high commodity prices), but there is more to it than just those factors.
Federal Reserve Chairman Ben Bernanke has said recently that monetary policy is not a panacea. We agree: monetary policy can’t do all the work which is why we still don’t expect QE3. With demand weak, and likely to remain so, a different approach to achieving higher economic growth is required. One of the implications of the revisions down in economic growth is that productivity (a supply side phenomenon) is now lower than previously thought. Instead of debating the debt ceiling, US politicians should be debating a more activist supply-side approach to building stronger US economic growth. The same goes for Europe.
The good news in the US GDP data was continued strength in capital expenditure. That bodes well for future growth. Given the constrained household sector, we continue to look to capex and exports to be the strongest areas of US growth.
Over the last few months we have moved to de-risk our portfolios by reducing our overweight in growth assets. With equities still cheap on most measures, this was against our normal inclination to want to be overweight growth. But with so much to worry about at the moment, it remains the most prudent positioning.