US ECONOMY HAS BEEN GAINING SOME TRACTION
Data suggests economic growth has been gaining some traction in the US. The government’s first estimate showed gross domestic product (GDP) in 2013’s second quarter grew at an annual rate of 1.7%. This is a modest rate of growth, but was well above many analysts’ expectations as robust domestic consumption and investment offset the drag from public spending cuts and fears of a slowing global economy. Indeed, the GDP figure appears to stands to be revised upward following the announcement of a much-improved trade balance in June, when exports reached an all-time high while imports fell. The most recent purchasing manager index (PMI) data for services and manufacturing have been strong, with durable goods orders picking up fast, while quarterly corporate profits have mostly exceeded expectations. Consumer confidence has been at its highest levels since 2008, and consumer spending rose at its fastest rate in seven months in July, according to the Department of Commerce. Although nonfarm payroll figures for July were somewhat weaker than expected and figures for job creation in previous months were revised downward, the official unemployment rate fell to 7.4% in July from 7.6% in the previous month, while the “household survey” compiled by the Bureau of Labor Statistics (BLS), which tends to better capture small-business hiring, was much stronger than the BLS’s nonfarm payroll figure.
With the effects of the so-called “fiscal drag” caused by federal spending cuts expected to fade, US growth is seen by many observers as likely to pick up through to the end of this year, barring unforeseen events. In such circumstances, the US Federal Reserve (Fed) may find greater confidence to begin tapering its asset purchases from the current level of about US$85 billion per month. An early end to speculation about tapering could provide more clarity and direction to financial markets and, in that sense, would be a welcome development, in our view. Such additional clarity may come with the release of the August jobs report in early September, followed by the next Fed policy meeting on 17–18 September.
For the moment, however, the July nonfarm payroll figures and an annual rate of inflation that is still well below the Fed’s target of 2% are undoubtedly giving Fed policymakers food for thought, nor can these same policymakers ignore the quite significant decline in the unemployment rate from 8.1% in August 2012. Additionally, in its most recent assessment of the economy at the end of July, the Fed felt sure that “inflation will move back toward its objective over the medium-term.”
After a rapid run-up in May and June, long-term US Treasury bond yields stabilised somewhat in July and early August as policymakers went out of their way to try and reassure financial markets that, whatever their decision about the continuation of the Fed’s monthly asset-purchase programme, short-term interest rates were going to stay at very low levels until unemployment falls to 6.5%. Other reasons explain the recent bond and currency market caution about the US: Wages are still not growing, the Fed itself has said the recent rise in mortgage rates will act as a restraint on growth, and the uncertain cost of Obamacare continues to weigh on corporate decision-making. And yet, as recent data suggest, the US looks in far better shape to record a potential rise in sustainable growth than many other parts of the world. The country’s financial system has largely been fixed and banks have relaxed their credit conditions; the 2013 rise to date in equity markets and home prices have been encouraging households to spend again—and they will likely find even more reason to do so if household debt levels decline and wages start to rise again; the household market, in spite of the recent hike in mortgage rates, should continue to be buoyed by factors both cyclical (such as low inventories and relaxed credit conditions) and structural (such as a rising population and an even faster rise in household formation); and lastly, many firms sitting on healthy profits and helped by the cheap energy boost from shale gas appear poised to invest again. All in all, while a number of American cities and states are having to battle with unfunded pension and health care promises, and while political wrangling over the federal budget will soon recommence, it seems reasonable to us to believe there could be further, progressive improvement in economic growth in the US for the rest of this year.
Franklin Templeton Fixed Income Team
