John Greenwood, Invesco chief economist, says in his latest quartely outlook that the economies of emerging Asia and Latin America will provide the strongest growth.
In short, 2013 will be another year of sub-par growth with low inflation as the dual problems of balance sheet repair in the developed economies and structural rebalancing in the emerging economies restrain overall spending growth.
In financial markets the US S&P 500 Index has largely ignored the problems of Europe, extending its rally since last November through the January-March quarter for a cumulative rise of 15%. However, despite the deepening economic downturn in the eurozone the FTSE Eurofirst 300 Index increased by about 14% in US$ terms over the same period.
Real GDP in 2012 Q4 was revised upwards from -0.1% as originally reported to +0.1%, mainly due to a 0.5 percentage point swing in the contribution from net exports. However, this downturn in performance should be viewed as a one-off event driven by the slump in defence spending and business inventories ahead of the “fiscal cliff” and unlikely to be extended in coming quarters. Growth in 2013 Q1 is likely to be in the neighbourhood of 2.5%, with improved housing values and rising wage rates counter-balancing the higher income and payroll taxes imposed under the fiscal cliff agreement. Nevertheless the Congressional Budget Office projects that the fiscal tightening — due to tax hikes and the sequester — will reduce economic growth by around 1.5% in 2013, creating a strong headwind for the private sector toovercome.
Looking ahead to Q2 and the second half of the year the US recovery is now broadly on track with personal consumption expenditure (PCE) and business investment likely to grow at solid, but unexciting, rates. PCE has been buffeted by the shifting of dividend payments into the final quarter of 2012 ahead of the expected income and payroll tax changes in the first two months of the year. However, with consumer confidence recovering, jobless claims falling, non-farm payroll employment rising by 236,000 jobs in February and wage rates on the rise again, PCE should grow at a moderate pace over the remainder of the year. Likewise, business investment has seen some stabilization after the plunge in orders in the second half of 2012, with new orders within the ISM data increasing by 4.5% in February to 57.8. Moreover, the ISM figures for manufacturing were strong across-the board in February with a reading of 54.2.
On the policy front Congress has now extended the administration’s spending authority (essentially delaying deep spending cuts) until September, thus averting the danger of a federal shut-down at the end of March. Consequently most of the action is going to be in the hands of the Fed, where there has been active debate about theappropriate size of the Fed’s $85bn monthly asset purchases. Since the continuation of Quantitative Easing is now dependent upon the unemployment rate falling below 6.5% on a sustainable basis, it was of significant interest to see the FOMC members’ economic forecasts released after their latest meeting. According to these data, fourteen out of nineteen members do not foresee unemployment falling below the 6.5% threshold until 2015 or 2016, suggesting it will be at least two years before the Fed will start to unwind its balance sheet expansion. Even so, the Fed could start reducing its rate of monthly asset purchases from $85bn per month to something less at an earlier time. In the words of Chairman Bernanke at the March FOMC press conference, “As we make progress toward our objective, we may adjust the flow rate of purchases from month to month to appropriately calibrate the amount of accommodation.”
Financial markets are likely to anticipate such shifts in strategy by the Fed, causing yields on “safe-haven” securities such as the Treasuries and MBS that the Fed has been buying to back up somewhat. Financial institutions have also been focused on the build-up of M&A transactions and the increase in debt issuance by non-financial corporations, but the Flow of Funds data for 2012 Q3 just released suggest that the US as a whole is still in de-leveraging mode, even if the pace of debt repayment has slowed. As long as these moves by the Fed or the renewed leveraging up in financial markets are not accompanied by any rise in the actual or expected inflation rate, or by any surge in the real growth rate of the economy, it seems unlikely that the shock to the markets will be comparable with the 1994-95 episode when US long rates backed up nearly 300 basis points.
Since I expect CPI inflation, which depends ultimately on broad money and credit growth, not the size of the Fed’s balance sheet, to remain subdued at around 1.7%, and real GDP growth also to be 1.7% over the calendar year, it is hard to envisage changes in Fed policy being the source of serious market disruption in 2013. Since I expect CPI inflation, which depends ultimately on broad money and credit growth, not the size of the Fed’s balance sheet, to remain subdued at around 1.7%, and real GDP growth also to be 1.7% over the calendar year, it is hard to envisage changes in Fed policy being the source of serious market disruption in 2013.