Tuesday, April 15, 2014

Business as Usual

Five years after our most recent once-in-a-generation economic calamity, is it safe to say that it’s back to business as usual from here with regards to the US economy?
The question coalesced out of three things:

The change in the overall sentiment of economic data, albeit still negative by historical perspective, has been stabilizing if not improving.

 Financial asset prices have maintained a persistent march higher in spite of restrictive monetary policy guidance from the Fed, low inflation expectations by most measures, and an economy stricken with production capacity slack, and a risk of hysteresis in the labor.

In an interview on Bloomberg, the head of the IMF said something to the effect of “everyone agrees that there is slack in the US economy, and need for investment…”.  

The data, first and foremost is telling a different story from during the midst of the crisis and ensuing recession. Without that underlying shift there wouldn’t be much room to quantify the change, since on a qualitative basis not much has change for a lot of people. Following the sentiment change in the economic data feed, the persistence of financial asset prices also stand out.

Historically, the equities market has lead the real economy [GDP, employment, etc] out of a recession and back to growth by about 3-4 fiscal quarters. Well stocks recovered their losses about a year-and-a-half or so ago, and have been making a series of new highs with little time spent correcting or retracing. Bond prices have also been elevated as a byproduct of the Fed’s easy monetary policy. But, even with more guidance from the Fed trying prepare markets for a more restrictive policy stance, bond prices have resisted most of the downward pressure.

Lastly, we have world leaders talking on a worldwide platform saying things like ‘everyone agrees…’. I think that a social consensus is much easier to build than a political one, and politicians try to mirror the consensus to appear legitimate, so if the international community is talking along these lines then maybe that’s where their money is too.

In a business as usual world, the dollar trends lower for many reasons, one of which is investors around the world seeking out risk in exchange for return by selling their relatively safe [low yielding] US investments and buy relatively riskier [higher yielding] international investments. To keep my life simple, I looked at the regression trend of prices of the front month dollar index futures over a twenty-year span, a ten-year span, and a five-year span. Suffice to say the 2008 crisis had enough of an impact that it changed the long term regression trend of the dollar. But, the effects are only reflected when the price data from 2009 – 2010 are included in the five-year measure. Basically, the rest of the world in terms of economic activity and capital flows, have been back to business as usual for over two-and-a-half years now.