Is the Economy Ready to Accelerate as U.S. Monetary Policy Becomes Less Accommodative?
For the first time in several years, we approach the new year without big clouds on the horizon. In the United States, accommodative monetary policy has healed many of the wounds from the 2008-2009 crisis. Key positive developments include:
▪ Balance sheet repair is now well underway
▪ The federal budget deficit has fallen from 10% to 4% of GDP1
▪ Banks are recapitalized and steadily working off bad loans
▪ The housing market has started to recover
▪ Corporations have high levels of profits and cash
▪ The household sector has dramatically reduced its debt service costs
▪ State and local governments are no longer cutting their budgets
▪ Additional fiscal austerity measures do not appear to be planned
▪ Another government shutdown is not likely because of the midterm elections
In 2014, we believe the economy will finally start growing at a healthy 3%. Prior economic advances have been impacted by U.S. policy austerity measures and investor confidence issues. The housing market and banking sector improved in 2012 with gains in home prices and construction, modest improvement in bank lending and less restrictive standards. Private sector balance sheet repair is the unsung success story of Federal Reserve (Fed) easy policy. Abundant liquidity has not prompted inflation or systematically risky bubbles, despite views of critics. Households have taken advantage of low interest rates to lower their monthly debt service costs to the lowest level in almost 30 years.2 Banks and corporations have rebuilt their balance sheets. Easy credit has not created imbalances in the real economy. The credit market has small pockets of excess, rather than the over-investment of the dot-com bubble or the overhang of single family homes during the subprime crisis.
A cyclical bounce has happened, but the United States is still in the early stages of the business cycle. Business cycles do not die from old age but rather from
over-expansion and inflation. Most cyclical sectors such as consumer durables and business fixed investment have not recovered to their normal recession share of GDP or made a full recovery.
World Economies Begin to Heal
We expect growth in Europe to remain low. In our view, policymakers amplified the acute phase of the European crisis. On the fiscal front, core countries were asking the periphery to do the impossible: tighten fiscal policy in a recession, or be denied funding. Peripheral countries are now being given more time to address budget problems. The European Central Bank (ECB) will probably introduce a new long-term refinancing option (LTRO) but otherwise refrain from easing policy significantly. Credit and fiscal policy remain tight, confidence is weak and the economy continues to muddle along. Our outlook has also improved for the rest of the world. We expect Abenomics to produce another 2% year of growth in Japan. In emerging markets, growth should pick up modestly, based on stronger growth in the developed world and a continued re-engagement of global manufacturing and trade. With low inflation (persistently below target), many central banks in the developed world face an unusual challenge of trying to raise inflation.
Economic Progress Also Has Risks
Downside risks to our outlook do not appear particularly high. But our evaluation could prove wrong or U.S. fiscal policy missteps might occur. Political events in Europe would possibly restart a crisis. The Japanese government may miscalculate its attempt to offset the consumption tax hike with other easy policies. Below the surface, China seems to have a problem with excessive credit expansion and unprofitable enterprises. A number of emerging market countries appear quite vulnerable if the exit by the Fed causes renewed panic in the market. There is also always the risk of another oil shock. Regarding upside risks, the United States could experience a stronger cyclical bounce as headwinds fade. Parts of emerging markets could recover quickly, as deleveraging slows and bank lending increases, particularly in Eastern Europe. There is also some upside risk to global manufacturing as the stock-building cycle strengthens. Yet overall the outlook appears balanced and healthier.
1 Source: Congressional Budget Office, “Updated Budget Projections: Fiscal Years 2013 to 2023,” May 14, 2013, www.cbo.gov. 2 Source: The Federal Reserve Board, “Household Debt Service and Financial Obligations Ratios,” December 13, 2013, http://www.federalreserve.gov/releases/housedebt/.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non- investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.
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