US – Taking Stock
Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.
As Janet Yellen’s four-year term as Chair of the Federal Reserve ends we take stock of the US economy and the environment she will be leaving after completing her term.
Having limped along in the wake of the global financial crisis the US economy is starting to evidence self-sustaining growth. The US central bank’s speedy response to the financial crisis in 2007/08 is credited with averting an even deeper recession forecast at the time. Their adoption of ultra-loose monetary policy measures, such as quantitative easing (a method to inject new capital into the economy) and reductions to interest rates (taking them to historic lows) was successful in stimulating economic growth in the US. So, now that the economy has recovered, interest rates have begun to rise and quantitative easing is being scaled back.
To get a general sense of the US economy the table below highlights key economic data points. You can see that unemployment has fallen and inflation (CPI) and interest rates have nudged up. Preliminary estimates released last week show an increase in annualised US gross domestic product (GDP) of 2.6%, down relative to prior quarterly snapshots, but this is before the recent tax cuts begin to take effect.
Source: Bloomberg, 31 January 2018 – % represents annualised rates
Consumption is a big driver of growth in the US thus personal spending matters a great deal. Spending accelerated from 2.2% to 3.8% in the final quarter of the year. The number of Americans filing for unemployment is a good barometer of economic health. It has ticked up slightly but remains just above its 45-year low point. On this basis, it is not too surprising that real wage growth is starting to improve. Moreover, although interest rates have ticked up, credit (borrowing) costs remain cheap by historic standards. All in all, this promotes household spending and contributes to a prosperous economy.
The inflation conundrum:
Signs that a broad-based global economic recovery is gathering pace with real wage growth and sweeping tax cuts represent a red ‘inflation alert’ flag for some commentators. Ironically, the absence of inflation is something that worries the US Federal Reserve Bank (The Fed) but inflation watchers are now left wondering if the Fed is ‘behind the curve’, i.e. slow to raise interest rates leading to a situation whereby monetary policy must be tightened quickly to stop the economy overheating.
While this is a risk, we note that the 10-year inflation breakeven rate, calculated by taking the difference in yield between a government bond and inflation linked bonds of the same term, is currently at 2.1%. This is in line with today’s consumer price inflation (CPI) of 2.1%.
US (1OYR) Breakeven Rate and US Inflation (CPI) – 5 Year Period
Source: Bloomberg, 02 February 2018
The Federal Open Market Committee (FOMC) acknowledge that inflation expectations have recently increased, and expect the rate of price changes “to move up this year” and stabilise around its 2% objective “over the medium term”.