Last week was a busy one in the US for economic data and economic policy. The Federal Reserve decided on interest rates and a slew of economic data were released. As expected, the Federal Reserve Open Market Committee (FOMC) lowered its target for the federal funds rate to 2% and indicated that it would wait to make the next move.
Two members of FOMC—Fisher and Plosser—dissented. They preferred no rate cut. They dissented the last time as well in March when FOMC lowered the federal funds rate by 75 basis points to 2.25%. Then, they favoured a less aggressive response. If their views had prevailed, the Fed rate would perhaps be at 2.5% now. The additional 50 basis points of rate cuts that we have got might or might not support growth, but it is already doing its job in stoking inflation worldwide.
Wanting to deflect attention from FOMC’s actions, many commentators ascribe the recent rise in commodities to speculative investors—but offer little proof. Their silence on evaluating the possibility that loose monetary policy pursued almost globally for the better part of the New Millennium has anything to do first with asset price inflation and later with consumer goods inflation is as deafening as their eloquence on discussing speculation as the predominant cause of the boom in commodities.
Tim Bond of Barclays Capital puts it well: “…Despite persistently high headline inflation rates, the Fed has refused to tolerate even a mild recession, thereby demonstrating that the objective of price stability is subordinate to the target of sustaining positive growth. The net result is that the US currently labours under a much higher inflation rate than most other advanced economies, even though economic growth is far weaker… The eventual end point of such a dovish bias will be a more entrenched inflationary trend and a deeper “policy recession” than might have been needed had the Fed acted in a more balanced manner.” (Suffering in the Seventies, Barclays Capital Research, 1 May).
The advance estimate of the US growth rate in the first quarter was released on 30 April. The economy grew at an annualized rate of 0.6% in real terms. Quarter on quarter, the growth rate barely registered. Further, the decline in residential investment spending was joined by a decline in non-residential structures and spending on equipment and software. But for the accumulation of inventories, the growth rate would have been negative. The rise in inventories sets up a disappointing second quarter for growth.
Much rides on the outlook for consumer spending that’s been the backbone of the economy. This, in turn, has been sustained by borrowing against rising value of homes. That is no longer feasible as equity in homes is fast turning negative, with home prices still in a corrective phase . The ABC News/Washington Post consumer comfort index has dropped to a low of -41. It is on track to drop lower than its worst level recorded in the 1990-91 recession. This gets little attention among economists.
The monthly consumer confidence board survey gives information on how respondents perceive the job market now as well as in six months’ time. Both are deteriorating rapidly.
Yet, data for March showed personal spending rising 0.4% in March while personal income rose 0.3%. The figures are not adjusted for spending on petrol. Yet, in the light of the information on jobs and income outlook, data show that spending retrenchment still lies ahead and is not behind us.
On Thursday, the US released the Institute of Supply Management (ISM) survey of purchasing managers. It was unchanged from the previous month, whereas consensus opinion anticipated a small drop. Prices paid by purchasing managers went up, indicating rising cost pressures. At the same time, new orders adjusted for inventory accumulation continue to lurch southward.
Despite such an obvious lack of positive catalysts, US equities rallied substantially on Thursday. It is hard to ascribe a fundamental explanation to it. If economic fundamentals remain as weak as they are, the outlook for earnings would not be bright and such staged rallies would eventually turn out to be both counterproductive and unsustainable.
It is appropriate to end this column with words from a long-standing investor: “…just take a deep breath, hunker down with cash, and live to fight another day. It’s a difficult task for most of us who easily get ants in our pants. Since I still believe that the US market will not bottom for some time —2010 still looks good—we must be prepared for plenty of rallies to fill in the time. High animal spirits, fortified for so long by good times and moral hazard, will not give ground easily.” (“Immoral hazard”, Jeremy Grantham, GMO Quarterly Letter, April 2008).
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at email@example.com