Consumer confidence is high, spending is on the up and jobs are being created, but is America’s economic recovery too good to be true?
The US economy appears to be surging ahead. Indeed, having registered 4% GDP quarter-on-quarter growth in the second quarter, some analysts say that its recovery momentum has finally reached ‘escape velocity’. Consumer confidence is higher than most predicted and real spending increased by 2.5%. More than 200,000 new jobs have been created each month over the first half of 2014, leaving the unemployment rate hovering just above 6%¹.
Moreover, US companies are much leaner following widespread restructuring forced on them by the last recession, enabling them to ‘re-shore’ production and jobs back to the US while at the same time generating strong corporate earnings. The country is benefiting from an unforeseen energy boom, largely thanks to fracking, and the abundance of cheap natural gas is encouraging investment in petrochemicals and energy-intensive industries. Forecasts by the US Energy Information Administration point to a 25%+ increase in crude oil production by 2015.
‘While there are plenty of positives, it is not a normal recovery by any means,’ says Franklin Allen, the life professor of finance and economics at the Wharton School, University of Pennsylvania, and executive director of the Brevan Howard Centre for Financial Analysis at Imperial College Business School. It is slower than previous recoveries and has been built on a platform of ultra-accommodative monetary policy.
‘A recovery, yes, but not a solid recovery,’ says Dr Gianluca Benigno of the London School of Economics, who points to continuing weak spots such as the housing market (US pending home sales slipped
1.1% in the month to the end of June)² and some forward indicators like the Purchasing Managers’ Index (PMI) coming in below expectations. He also notes that last quarter’s uplift in GDP ‘was largely due to increases in consumption and non-recurring build-ups of inventory. We would like to see more from business investment.’
Allen cites concerns about the labour market. ‘New jobs are being created, but the participation level is still at historically low levels. Future earnings growth and promotion prospects for young people do not look good. And while household debt is down, people feel less secure about the future and are unwilling to spend.’
He adds that ‘keeping interest rates too low in the early 2000s created bubbles in the housing market. Now we have had low rates for longer [than at the start of the century]. It is perfectly fine to keep interest rates low for a short period, but if that goes on for years the economy adapts to it. Japan became hooked on low interest rates and is finding it very difficult to break away [from ultra-low interest rates]. It’s very dangerous in the long run.’
Professor Arvind Krishnamurthy at Stanford University, California, says: ‘At the peak of the crisis in 2008/09, quantitative easing [QE] added liquidity to financial markets at a time when liquidity had vanished, and thereby helped to stabilise markets and the economy. ‘Later, as the crisis abated, the Fed’s purchase of mortgage-backed securities [part of the process of QE] has been important in keeping mortgage rates low and fostering the slow recovery of the housing market.’ He also believes that the QE programme has made the Fed’s commitment to keep rates low more credible.
But with the Fed’s asset purchases finishing in October, how will forward guidance work on its own? Some foresee a sharp market sell-off – similar to the ‘taper tantrum’ that followed the Fed’s announcement in May 2013 that it would be gradually reducing its asset purchases – and fear that this might push the US recovery off course.
This is unlikely, says Krishnamurthy, because ‘the Fed has been effective, post-taper tantrum, in separating QE from forward guidance. This is why continued tapering is not having the dislocations that it did back then. ‘My expectation is that the exit from QE will continue smoothly without having significant negative consequences. That said, I expect that [it] will impact mortgage rates in particular, pushing these rates up.’
The Fed has a delicate balancing act ahead of it in moving towards ‘normalcy’ in monetary policy, while not spooking the markets and thereby derailing the broader US recovery. Benigno says: ‘Looking ahead, we expect the US economy to grow at a steady rate, but below previous recovery rates.
‘And while the recovery is not that strong, inflationary pressures are nonetheless mounting. US wages and salaries rose in the second quarter at the fastest rate in six years and unemployment dropped to near 6%. Consequently, inflationary pressure could force the Fed to raise interest rates earlier than indicated, possibly by the end of this year.’
That might dampen asset prices, particularly US Treasuries. But if wage rises are gradual and sustainable, then a continuation of low inflation and a strong US dollar could create a virtuous circle, drawing in new investment seeking higher returns and allowing economic growth to continue its upward trajectory.
1 Bureau of Labor Statistics (Sept 2014)
2 Marketwatch.com (July 2014)