City National Rochdale Economic Perspectives
Renewed Growth Ahead
After a disappointing start to the year, improvement in a wide range of
economic data has made us more confident not only in a stronger second quarter,
but also in the fact that the foundation for a sustained period of moderate
growth appears to be in place. Even though GDP in the first quarter was revised
into negative, for the first drop since 2011, underlying strength in the economy
is certainly more positive than the data suggests.
Despite earlier headwinds, private domestic demand managed to maintain most
of its momentum in the first quarter, rising by 2.1% year over year.
Additionally, given the recent pickup in job gains and the improvement in
household balance sheets, there is every reason to expect demand to increase in
the months ahead. With consumers providing a steady drive, economic activity
should build on itself and become reinforcing – encouraging more production,
business investment, and improvements in housing, which should add to growth in
the second half of the year.
Fundamentals relating to the consumer are well supported. Payroll employment
has increased now for 51 months, and it is almost certain to move above its
prior peak this month or next. Faster job growth should continue to support
improving wage growth, and with inflation subdued, boost real incomes, which
should provide greater purchasing power to the beleaguered American consumer. At
the same time, household balance sheets are now strong enough to support
increases in debt, and banks in turn are continuing to ease standards, hoping to
ignite further borrowing.
A period of stronger investment growth would also sit comfortably with the
loosening of lending criteria by banks. In fact, by the end of April, bank loans
to businesses rose by an annualized rate of 16.0% over the past three months as
compared to the three months prior, indicating that the steady slowdown in
private investment growth in the past two years may soon come to an end. Now
that some firms are reaching capacity constraints, they have little choice but
to buy more equipment to raise production. Exports, too, are expected to
continue to be supported by stronger international demand in key markets. While
the slowdown in emerging markets continues to weigh on global growth, in this
regard, a healthier Eurozone is more important to U.S. exporters than a weaker
The recent retrenchment in yields reflects, in part, deflationary impulses
abroad and a flight to quality (due to geopolitical concerns, among other
issues) rather than a signal by markets of potential economic weakness ahead.
The good news is that lower bond yields have also lowered mortgage rates and
should support a much-needed rebound in the housing market. Housing data has
already shown signs of turning a corner, with home sales, housing starts, and
building permits rising in April. As firms expand payrolls and household
formation continues to slowly build, we believe the housing picture will
We expect a continuing buildup in economic momentum, evidenced by an
improving labor market and gradually increasing price pressures, to allow the
Fed to bring bond-buying to an end as scheduled later this year. The first rate
hike is not expected until the middle of 2015 and is likely to be only gradual.
However, the Fed will likely remain accommodative and cautious on its exit plan;
its decision to tighten will be based on the improvement in the economy and not
on the calendar.
While the recent strength in domestic indicators is welcome, markets have
taken a more cautious stance, with stock prices moving sideways as bond markets
have rallied. We expect sentiment to eventually return to equity markets, though
returns may be volatile in the near term. Economic improvement, however, should
help boost corporate profitability and ultimately stock prices over the long
THE FED Ever since the makers of domestic monetary policy
began the asset purchase program (quantitative easing) back in 2008, they have
been eager to find a way to exit this nontraditional method of providing
stimulus to the economy. Earlier this year, they began tapering their monthly
purchases of treasury and mortgage bonds – at the current pace, additional
purchases should conclude by the fall. In regard to the portfolio, the Fed has
been reinvesting all coupon and principal payments. Since 2011, the belief had
been that the Fed would stop this reinvestment, allowing the portfolio to
gradually shrink before it initiated raising interest rates. However, on May 20,
William Dudley, president of the Federal Reserve Bank of New York and one of the
most influential members of the Federal Open Market Committee (FOMC), stated
that the Fed should keep reinvesting in its mortgage portfolio until after it
begins to raise interest rates. Doing this will help keep mortgage rates low,
which would benefit the beleaguered housing market; it will allow the Fed to
move off ZIRP (zero interest rate policy) sooner; and it will provide greater
monetary policy flexibility in the future – as the Fed will be able to cut rates
if weaker economic growth requires immediate stimulus.
EMPLOYMENT Labor market conditions are improving
significantly after the winter lull. The April employment report showed
broad-based improvement, a marked change from a couple months of weak job
reports at the beginning of the year. Additionally, upward revisions to the
previous month’s report suggest the economy is stronger than formerly thought.
This is reassuring and rekindles a confidence that the economy can break out of
the long-standing muddle that pervades the current situation. The average
monthly job gain in five of the past seven months (excluding January and
February) is an impressive 245,000.
The April nonfarm payrolls rose 288,000, the best monthly showing in more
than two years. The unemployment rate plunged to 6.3% from 6.7% – a new cycle
low and its lowest level in more than five years. That being said, we may not
want to read too much into this as the drop was due to a decrease in the
workforce (the denominator in the unemployment rate equation), which may be due
to the expiration of extended unemployment insurance benefits. Despite the
improvement in payroll gains, employees do not have bargaining power for better
wages. The average hourly earnings increase over the past 12 months is a meager
1.9%, about the same as the inflation rate of 2.0%.
INFLATION Increases in consumer prices have gained momentum
over the past two months. The yearly change in consumer prices has jumped to
2.0%, which is a noticeable paradigm shift as this rate was just 1.1% two months
ago. At that time, there was little expectation of inflation almost doubling in
such a short time frame. Against the backdrop of declining global inflation
(Europe is fearful of deflation setting in), this shift becomes even more
curious. Domestically, there has been a substantial increase in food prices
(meat, poultry, and eggs have increased 6.5% over the past year due to the
drought in the West), gasoline prices are up 2.4%, and housing has increased
2.5% – all during the same time frame.
The Fed is not expected to change monetary policy based on this recent
increase. The Fed’s preferred measurement of inflation, core personal
consumption expenditures – which excludes food and energy prices and has a
smaller attribution to housing costs – is up just 1.4% and is well below the
Fed’s target rate of 2.0%. All this slack in the labor market has Fed officials
believing that inflation cannot get out of control.
EUROZONE The past several years’ worth of recessions,
sovereign debt crises, instability in the banking system, and austerity have
served as a collective drag on economic growth. After recovering from a
double-dip recession, economic growth has advanced just 0.5% in the past year,
placing total economic output at 2.5% below the peak prior to the Great
Recession (the United States is 6.0% above the previous peak). The unemployment
rate remains stubbornly high near 12.0%, and some countries in the southern part
of the continent have unemployment rates exceeding 25.0%. Inflation has fallen
to just 0.7%, and the European Central Bank (ECB) is committed to the resumption
of stimulating the economy to increase inflationary pressures and economic
Despite being sluggish at getting back on the economic track, growth is
headed in a positive trajectory, albeit slowly. Rebounding from the crippling
sovereign debt crisis (Greek 10-year yields are just above 6.0%; two years ago,
they were above 35.0%), the manufacturing sector has been improving for more
than a year. The ECB’s use of unconventional policy measures is expected to go
far in the continuation of turning many of the long-standing headwinds into
Charts of the Month - Eurozone
Economic growth in the Eurozone has been expanding since the end of the
recession, but disagreements on how to resolve many of the economic, banking,
and sovereign debt problems have plagued the recovery.
The pace of economic growth varies between countries; generally speaking, the
northern, more industrialized countries have had better economic growth since
the end of the Great Recession.
This variance in economic growth has had a direct link to the unemployment
rate in each of the countries.
The good news for the Eurozone is that the sovereign debt crisis appears to
be a problem of the past.
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