You’re on your own, kids
James Saft is a Reuters columnist. The opinions expressed are his own.
First came the realization that U.S. economic growth was fading. Now comes the dawning feeling that no meaningful help is on the way.
There is no sign of significant new stimulative government spending and little chance that the Federal Reserve will be willing, much less able, to follow up with another round of quantitative easing.
As for the global economy, Europe is in its own crisis and that transition to a consumer economy in China is going to take a while.
For investors used to more than a decade of bailouts, this will be a rude shock and will follow the usual pattern of denial through to acceptance.
Government bonds will get yet another boost, as will the U.S. dollar, while equities and other expressions of risk appetite will get pummelled.
Friday’s jobs report brought home just how feeble the U.S. economy is with non-farm payrolls rising by just 54,000 in May, about 100,000 less than is needed to merely keep employment stable. Private sector hiring was disappointing, but so too was government employment, which has been on a long, slow descent.
The data merely confirmed what was already apparent: economic growth began to slow in the first quarter and has slowed further as the year has gone on.
While lots of attention is paid to the things that have changed and are hurting the economy — energy prices and freak weather — the fundamentals driving the economy are really unchanged. Households have too much debt, supported by too little earnings and secured against, in many cases, assets with diminishing value like real estate.
The Pavlovian response among investors has been to figure that a weak economy and weakening markets will bring further government stimulus; after all for many that’s all they have ever known.
This time is going to be different, for good or ill.
“We have shifted in the economy from a rescue phase, which is government-directed, to a phase in which we’ve got to rely on government policies that are trying to leverage the private sector and give incentives to the private sector to be doing the growth,” Austan Goolsbee, the head of White House Council of Economic Advisors said on ABC television.
While Goolsbee may believe this, it wouldn’t matter if he didn’t because the Administration has little choice but to hope the private sector can do something; the public sector will not.
While there are proposals for stimulative measures — like an infrastructure bank — they are either blocked in Congress by Republican opposition, are too small to make a difference, or both.
This is the great unaccounted-for cost of the TARP and other rescue plans dating from 2008. They poisoned public opinion against all government stimulus, tying the hands of the current Administration and very likely of future ones.
The debate has moved firmly towards budget cuts, and while those are an ultimate necessity, the market has not quite caught up with their economic implications. It is not just bureaucrats who will be thrown out of jobs, private sector employment and profits will take big hits too.
As for the Federal Reserve, things would have to get a lot worse, as well they may, before they can be expected to weigh in with another round of QE. While “QE2″ fulfilled its aim in driving equity prices up and the dollar down, there is genuine controversy over what the risk/reward trade off actually is.
Federal Reserve vice chair Janet Yellen last week acknowledged that, taken too far, the sort of “reaching for yield” the Fed has engineered can lead to dangerous financial imbalances.
Almost more to the point, even if the Fed wanted to go further with extraordinary measures it faces real political risks and costs if it does. QE2 has been very unpopular in certain quarters. This is partly because of fears of inflation, but also because many Republicans view it as fiscal policy by another name, and its use as a unilateral infringement of Congress’ powers.
Wrong this may be, but it will be increasingly difficult for the Fed to act again as the 2012 election cycle kicks off, raising the bar for further action.
So, how does this play out in financial markets? It is very positive for government bonds, even in the face of the debt ceiling negotiations. The economy is doing poorly and will get little further support. The dollar should do well too, as investors come to realize that there will be no additional (virtual) money printing.
For equities and other risk assets it will be, of course, bad. It will take a while for the new reality to sink in, but when it does look for conditions that are just bad enough to bring consensus on rescues, stimulus and extraordinary measures yet unimagined.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)