Yes, I had a great holiday. Thanks for asking. It was quite an action-packed three weeks with fiscal cliff negotiations, FOMC minutes sending shivers through bond markets and a raft of data out of China, supporting our suspicions that GDP activity recovered somewhat into the end of 2012.
The biggest news was the part-resolution of
the “fiscal cliff” in America.
Politicians belatedly reached agreement on the tax aspects of the
problem but as we suspected, expenditure (sequestration) was too hot to handle
and that can got kicked down the road.
But not too far; expenditure will be discussed again shortly as part of
the raising of the debt ceiling debate which needs to take place by end of
February/early March. More importantly,
in the absence of a “Grand Bargain”, fiscal policy in America will continue to
be a make-it-up-as-you-go process. For
more on the “fiscal cliff”, see the post below.
Recent activity data supports the view of
the US economy finishing the year with modest growth, but improving
fundamentals more generally. December
PMI data was good, though not spectacular, and housing data has continued to
support the view of a recovery emerging in that market. The labour market held up well into the end
of the year with a 155k increase in non-farm payrolls in December. If anecdotal evidence is correct, firms have
been delaying hiring and investment decisions.
That could see some stronger employment gains in the months ahead and
some recovery in capital spending.
Our working assumption has been that US
fiscal drag in 2013 would be around twice that of 2012. GDP growth looks set to come in around 2.3%
(annual average) for calendar 2012. With
fiscal drag of around 0.7% over the year, growth would have been around 3.0%
without the contractionary influence of fiscal policy. In 2013, we think fiscal drag will be around
1.5%. Our forecast for GDP growth for
the year is 2.1% or around 3.5% without the fiscal drag. That feels about right, especially given the modestly
improving housing market.
The US bond
market took fright with the release of the minutes of the December Federal Open
Market Committee meeting, with concern that QE3 might end as early as the
middle of this year. These supposedly
“hawkish” comments saw bond yields up sharply.
Isn’t it amazing what’s considered hawkish these days? It’s too early to tell how long QE3 runs for,
but given our view that US GDP growth will most likely demonstrate an
accelerating profile over the course of 2013, I think it’s likely we will at
least see a reduction in the quantum of QE (currently $85 billion per month)
later in the year. Anything beyond that
will depend on the labour market and the path of inflation, particularly the
personal consumption expenditure (PCE) deflator.
Economic activity remains weak in
Europe. Business sentiment remains soft
and the labour market continues to weaken: Europe’s unemployment rate reached
11.8% in November. Latest PMI data
suggests that while the recession isn’t getting any deeper, but neither does
there appear to be any chance of imminent recovery. We think the earliest we will see a return to
growth in Europe is late this year. The
ECB left interest rate unchanged last week.
I’m ok with that; any cut to interest rates now would be largely
symbolic, rather than having any meaningful impact on economic activity. Perhaps the biggest news of the last few
weeks in Europe was, once again, politics with an election likely in Italy In
February. Mario Monti, the caretaker
Prime Minister, will stand again. That’s
In Japan activity data remains weak and
prices continue to fall. That supports
Prime Minister Abe’s call for more aggressive monetary policy action. While in the past I have questioned the
merits of quantitative easing for the purposes of influencing real activity in
the economy, it is more effective with respect to combating deflation. QE could and should have been used more
aggressively in Japan. Raising the Bank of
Japan’s (recently introduced) inflation target from 1% to 2% would also help lift
inflation expectations, but needs to be followed up with aggressive monetary
policy action. Last week the new
Government announced a new fiscal stimulus package which should help see Japan
out of the current recession later this year.
In China recent data has supported our view
that GDP growth recovered into the end of 2012 but also that the recovery will
likely remain modest overall. Export
growth was strong in December, although the data can be volatile. Money supply and loans data is trending
gradually higher. We continue to expect
a stronger recovery in industrial production as the inventory cycle turns.
Inflation in China nudged higher in
December on the back of a weather-induced increase in food prices, but underlying
inflation pressures appear well-contained.
Nevertheless, as inflation edges higher over the period ahead,
authorities will remain constrained to monetary policy fine-tuning rather than
anything more aggressive. I will have
more to say on China on Friday after the release of Q4 2012 GDP data. We expect annual growth of 7.8%.