I have been off since Thursday due to the Easter holiday. But I want to write my traditional Friday post today with a grab bag of different issues I am seeing. I actually just want to focus on the US this time.
United States. As the year began, I was not bearish on the US economy. We were looking at a 2% baseline growth rate due to 1%+ wage growth and incipient releveraging. The potential for a capex-induced uptick made the risk for US data to the upside in my view. As the year began, I was talking about how tightening into frothy markets in the asset-based economy meant pulling forward credit demand and goosing GDP growth as a result.
But then we got disastrous weather that killed demand and hurt the jobs market, so that during January and February, the figures surprised to the downside. Inventory builds and the subpriming of the auto market showed problems in the US that by February could not continue for much longer without an inventory purge. The combination of this weakness and a nascent emerging markets crisis had me predicting lower bond yields, lower stock prices and lower GDP growth in the US when I did my Ten Surprises for 2014. Again, I am (still) looking at a 2% baseline, weakened or strengthened by short-term noise. The noise in January and February was enough to materially weaken the outlook in the US. And the trend was also poor.
The move from QE to forward guidance has always been about normalizing policy. That means tightening. If the Fed tightens into a weakening demand situation as we saw in January and February, the result is a sell-off in markets and reduced credit demand. However, with a 2% baseline strengthened by lower jobless claims, continued releveraging, higher wage growth and/or business capital investment, tightening will pull forward demand and increase GDP growth.
So where does that leave us now? It is hard to say. But I still believe the US could accelerate higher in 2014 now that the EM crisis has passed and if the demand and jobs problems in January and February were all weather-related. That doesn’t mean we are off into a 4%+ growth scenario. But we would be in a 2%+ growth scenario that would support both the real economy and asset prices. I see four key variables:
- Jobs. I am using the y-o-y change in initial jobless claims as a proxy for the jobs market. If jobless claims rise, then it shows a business cycle that is nearing an end or a mid-cycle slowing like 1994 for example. If jobless claims decline that is a sign of a tightening labor market, especially at these cycle low 300k levels.
- Releveraging. There is some truth to the secular stagnation meme. Basically, as soon as real wages rise, the Fed gets spooked about the prospect for inflation and tightens. So real wages have gone nowhere for a generation except during the Clinton days, buoyed by the TMT bubble that ended in 3.9% unemployment. The US has been able to overcome this by relying on rising household debt levels and declining interest rates, which together have added credit at a relatively benign level of debt servicing costs. Likely, rates will remain relatively low, giving households room for releveraging, adding to credit demand and growth.
- Capex. So far this cycle, businesses have not added to GDP growth by boosting capex. To the degree we have seen credit growth in the business sector, much of it has been of a financial engineering variety, with businesses locking in low debt levels as they take on debt and buy back shares, boosting earnings in the process. What we would like to see is GDP growth-stimulating business investment. I believe capex will be a big signal because it shows business confidence that will boost GDP growth through not just capex but likely higher jobs or wages.
- Wages. And the last thing to look for here is wage growth because that’s going to be the source of sustainable secular momentum that is not dependent on releveraging or an increase in labor participation or the work force. Watc for the Fed’s reaction function on this front. Yellen seems to suggest she wants to allow wage and job growth to take form at the risk of consumer price inflation, especially because the CPI remains muted. But, in the past, the Fed has snuffed out recoveries when wage growth accelerated. The big exception was the late 1990s – and that led to a massive equity bubble.
The US economy is not near recession. It is putting along at the 2% level and could see a material uptick in this level if the four variables outlined before come to assistance. But the US is still excessively dependent on an asset-based economic model that is unsustainable. if the US economy turns up, expect asset prices to move into bubble territory, presaging a crash and financial difficulties. If the US were not over-reliant on monetary policy via tight fiscal, loose monetary we might see wage growth without asset price growth. Instead we are seeing asset price growth without wage growth. And when wage growth does appear, asset prices will move into bubble territory.
Steady as she goes though… for now.