US Economic Stimulus
The economic underperformance of the Developed countries
continues. Among the developed
countries, US continues to do well. The Q3 adopted by the US government brought
some semblance to the global markets and provided stimulus not only for the US
economy but also to other economies around the world. The global investors /corporations
were able to source low cost funds from US. The low interest loans were
available to US corporates, Households and there was a good momentum created in
the construction front in the US.
The overall competitiveness of US is improving supported by availability
of cheap gas. The government has drawn up a strategy to revive the
manufacturing sector and there are many new initiatives on the way to regain
the competitiveness. The exports of consumer goods and consumer durables from
US has started going up.
The announcement that US was about to
withdraw the stimulus had a global impact and funds invested in emerging
markets were withdrawn by the investors and there was a volatility in the
emerging financial markets after the announcement. This has affected the global
financial markets.
While announcing Q3 , the government
mentioned that the withdrawal would depend on two factors that is unemployment
level reaching 6.5% and inflation at 2%. The government also expected that the
economic growth would be at a much higher level by adopting Q3. There is a
significant movement in all these parameters towards achieving the goals but it will take at least a year from
now to reach the targets set by the Government .
There was an improvement in Trade data
reported recently which is again a good movement towards achievement of set
economic targets.
The adoption of indicator based
approach during the economic crisis is a good method and it provides an
objective basis for decision making to the authorities. Looking at these
indicators, July 31st Statement of Fed did not give any indication
of any tapering by September as many of the Analysts were predicting.
Economic growth in First two quarters
was lower than expectations and the
first quarter growth number was revised down to 1.8% from 2.4%. But the growth in
the second of fed fiscal year is likely to pick up momentum.
Inflation in 2012 was at 2.1% and it
is likely to come down to 1.6% in 2013
and it is expected to be in the range of 2.2% in the next few years.
Consumer spending rose by 3.4% in the first quarter, fixed investments
by 4.1% and Residential investment by 12.1%.
All the corporates in US have a cash (
global resources )of more than $ 5 trn and non financial companies have a cash
of more than $ 2 trn. They have started investing in Capex and many companies
having high cash reserves will declare high dividends. This will increase the
dividend yield for many companies.
The corporate sector performance in Q2
is likely to be better but as per analyst estimates , US has one of the high
P/e ratios in the history. The banks had reported very good performance in Q2.
The government is able to move toward
its target of sequestration and the budget deficit is likely to be down to 2%
by 2017.
2.2 mn new jobs were created in 2012
and 6.3 mn since the employment level bottomed out. Wages are still growing.
Household debt to disposable income
fell from 126% before recession to 104% by the first quarter. There is a favourable trend showing a
movement towards 90 – 95% under normal circumstances. Housing starts in first quarter
was 968,000 annualised in Q1, 35% higher than the previous year.
Net wealth of US household sector has
increased by nearly $ 15trn over the past three years.
US is not facing a short term fiscal
deficit problem.
Recovery today does not look secure to
withdraw the monetary stimulus immediately and it is likely to happen by July
2014 as per the above point.
In the past six months, congress made
adjustments to both spending side and taxes and the deficit is likely to come
down to reasonable levels.
At the end of 2012, Bush era income
tax cuts were made permanent for low and middle income wage earners. Taxes rose
for wealthier Americans. Wealthy will pay higher dividend, capital gains and
estate taxes.
On the spending side $ 2.1 trn was
identified. $ 900 bn of back loaded costs have already been settled and
underway. Other $ 1.2 trn “sequester” focuses heavily on cuts to defence and
other discretionary items. Despite there are concerns that this may not happen,
there is a high likelihood that this would be implemented.
The government is taking special
management steps to stretch its resources for several more months, putting off
the real debt ceiling deadline until October.
Immigration reform would enable 12
million undocumented immigrants , to fill the job openings . This will create
income opportunities for these immigrants thereby creating additional national
income and consumer demand.
This reform would help the new
manufacturing strategy of US which is based on low price for shale gas in US.
Using the availability of this gas, the government has decided to revive the
manufacturing sector and many of the imported items from countries like china
will be produced in US going forward. The imports will go down and the trade
deficit will be down.
S& P price gains seven months in a
row up 15.4% between Nov 12 – May 13. Earnings are likely to beat forecasts.
YTD returns from S&P was at 12.6%
by the end of June. MSCI emer markets had shown a negative return of 10.9% and
10 year treasury yield was up by 41.5%. The UBS commodity index was down by
10.5%.
Looking at the globe, Europe continues
to be under economic pressure and the solutions are still not in immediate site
and in Middle east, the political tensions are a great threat. Among BRIC ,
China is doing better but its performance levels were down compared to the peak
and there is a pressure on exports. Considering all the above and the US
increasing self dependence and better management of the economy supported by
improving corporate performance and increasing household wealth, US is becoming
attractive for investments.
The uncertainty prevails on when the Economic Stimulus would be
withdrawn and the feeling is that the process would start soon from the month
of September. From the present indications it would take a few more months to
achieve the stability expected by the US government. The government’s approach to
adoption of indicator based approach for action plans should be intact. There could be a clear communication from the authorities that the
stimulus withdrawal will be based on achievement of defined targets on
Unemployment and inflation.
Whatever is said and done, one day the stimulus withdrawal has
to start and the withdrawal could be made smooth by gradual withdrawal over a
period of time. From the present indications, the whole process should take at
least 2 to 3 years and the withdrawal could start with gradual reduction of purchase
of bonds. To start with, reduce the purchase size by $ 2 bn a month and a maximum
increment withdrawal in a month could be $ 5bn. When the bond purchase programme achieves the
level of $ 40 bn a month, then the Fed could look at increase in the interest
rates in phases. The incremental increase in every instance could be 10 bps.
The interest rates could be gradually increased. The programme for withdrawal
could be drawn up looking at various scenarios and how it will affect the bond
portfolio of banks and how it will affect the international financial system. The
plan drawn up could be made less painful for those segments which are going to
be affected due to withdrawal. From the present indicators, it appears that the
first phase of withdrawal could be started in the month of March 2014 and the
phased programme could be implemented.
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