Watch out for the policy drag: James Saft

February 9, 2012

By James Saft

(Reuters) – A strengthening U.S. jobs picture is the best news in months, carrying within it confirmation of the fruits of a pleasant rebound in American manufacturing.

That said, of the three sources of power for a recovery – private activity, public activity and monetary policy – only one will be a source of strength in the coming months, while the others may well prove a drag.

First, the good news; January’s payrolls data was strong, exceeded expectations, included positive revisions to previous months and, best of all, established something approaching a positive trend. Hours worked are growing more quickly than employment, hinting at hiring to come if employers gain confidence. It is just about possible to put together a thesis that those Americans with jobs are feeling a bit more secure and are finally going ahead with long-deferred purchases of big ticket items like autos.

This hints at something we’ve not yet seen since the bubble popped; a self-sustaining recovery.

The problem with that line of thinking is that we are nowhere near where we usually might be three years into a recovery. That’s because it’s a balance sheet recovery, characterized by paying back of debt and hemmed by the kinds of complications, political and economic, that you get when debt expansion, that great engine of growth in the past 20 years, has stalled.

First off, have a look at U.S. monetary policy. An examination of the Fed’s own forecasts shows that they are insufficiently loose based on the course of the economy they themselves expect. Under normal circumstances, you’d bet on a cut, in this case one put in effect by quantitative easing. That is far from a done deal, and even less so after the new run of data. There are deep divisions within the Federal Reserve about the wisdom of keeping rates extremely low for a long period, and a run of decent data may tip the scales away from further easing.

While it is impossible to predict if standing pat, or even tightening, would be a good move, one thing is clear: current financial market asset prices are predicated on expectations that the Fed will keep the punch flowing and well spiked.

Investors who are used to the comfortable notion that the Fed will step in if things get bad may pull back from riskier assets if they think that is no longer the case. So, on the margins monetary policy is probably going to be less supportive than we assumed before the jobs data, both of the real economy and the sand castle economy anchored by asset prices.


One of the commonplace observations about the jobs data is that it makes the re-election of President Obama more likely. That may well be true, but what it doesn’t make more likely, especially in the coming months, is cooperation towards a slow improvement in the fiscal outlook. The emphasis here is on slow, because even in the best of circumstances, declining government spending and employment is going to be a drag on the economy.

Fed chief Ben Bernanke was unusually blunt, for a central banker, last week in remarks before Congress about the risks of sharp cutbacks in spending.

“Even as fiscal policymakers address the urgent issue of fiscal sustainability, they should take care not to unnecessarily impede the current economic recovery,” Bernanke said. “The sluggish expansion has left the economy vulnerable to shocks.”

One of the prime shocks heading the country’s way will be through government spending cuts, and while the $500 billion dictated by current law won’t be felt until 2013, the rhetoric may become more extreme during the presidential campaign. This could spook investors, especially international ones, many of whom may not be in touch with exactly how divided the U.S. is on the issue and how dire the impact of deep cuts will be.

So, we return to the private economy as the source of hope, and here, while things have improved in recent months, there are still major problems. Housing prices remain soft, and the resolution of bottlenecks in the U.S. foreclosure process, while welcome, only means that we will be feeling some pain we deferred earlier. This is going to underscore for consumers exactly how much saving they also deferred during the boom years, making a strong burst of consumption unlikely.

And what about the impact from the rest of the world? Greece may eject itself from the euro, something that would be so negative for global growth that perhaps the best argument against it happening is that both sides couldn’t possibly be so stupid. Even if wisdom prevails, the U.S. still has to cope with the deflationary impact of a euro zone recession in 2012.

The U.S. jobs recovery is too fragile and too subject to outside shocks for comfort.

(Editing by James Dalgleish)

(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. For previous columns by James Saft, click on).

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James thanks for your article. Your perspectives, not lacking gravitas, employ that certain reassuring quality of hearing the other shoe drop.
My cynical side has left me feeling the news cycle had been captured since the run-up to Black Friday and through the holiday, retail, and year end bonus season, which somehow has folded seamlessly into bizarro campaign season, and all the insanity that entails.
Are we supposed to somehow ignore or forget the future fiscal and economic realities ?

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