Why a US recovery is a cause for caution
Just how strong is the recovery in the US? That’s the question everyone’s asking as global growth slows and the US offers the only glimmer of hope among the major economies.
Economic growth in America has averaged 4 per cent over the past two quarters after a slow start to the year and wages are growing, albeit slowly. Headline unemployment has fallen steadily and is now near six-year lows.
The Federal Reserve is expected to raise interest rates (we think in mid-2015) for the first time since 2006. This will be acknowledgement that policymakers are finally satisfied with the progress made in job creation and that they believe the economy is back on firmer ground.
But there is also a conflicting narrative about employment. The recovery hasn’t been so good for the fresh graduate who is struggling to find work or can only get minimum-wage or part-time jobs.
Nor has it been fantastic for members of the so-called “boomerang generation” who have been working a few years but still rely on mum and dad for financial support. By one estimate, around one in five Americans in their 20s and early 30s is living with their parents.
The dollar has strengthened against every other G10 currency this year
As we look ahead to 2015 it is a close call as to which narrative will prevail. We’ve been closely following US unemployment data that accounts for those stuck in part-time and casual jobs, the so-called U-6 measure of unemployment. This broader gauge has been improving steadily since 2010 but is still higher than pre-crisis levels.
While the jury’s still out, the markets are betting that conditions will improve enough for the Fed to raise interest rates next year.
The most telling sign of this expectation is the dollar’s revival. From an embattled currency that inspired an entire cottage industry predicting its demise, the dollar has strengthened against every other G10 currency this year.
But risks still linger. It’s not just in labour markets that the data seems ambiguous. The annual post-Thanksgiving sales season has been disappointing, which suggests consumers remain cautious. This may be important as household purchases account for around 70 per cent of the US economy.
Even so, we think the US recovery is here to stay. That’s because we’ve started to see a revival in corporate capital expenditure from fairly suppressed levels. This suggests US companies are more optimistic about the future and are beginning to invest again.
What’s more, there is further cause for optimism in this year’s slump in global oil prices. The commodity is as much a victim of over-supply, as major producers fail to agree on production curbs, as it is a casualty of weaker demand from slowing engines of growth. Cheaper oil, and by default lower energy and gasoline prices, will help the economic recovery by boosting consumer confidence and lowering costs for many industries.
In fact, one of our key risk scenarios sees bond markets shaken by multiple rate increases by Fed policymakers next year. This is a scenario that anticipates the end of a US labour market in which workers significantly exceed jobs, as the recovery leads to faster job creation. We think lower participation in the labour market is, to some extent, structural as there may not be enough people with the right skills to fill all these new jobs. One reason for this is an ageing population.
In this risk scenario, a tighter labour market won’t be a problem in the short-term. However, we already see the first signs of wage pressures in selected industries along with scattered indications of rising labour costs in general. Some employers have also reported difficulties in hiring staff with specialist skills. It suggests a real risk of higher wage costs and subsequent inflationary pressures.
This is not our central case view, but nonetheless a realistic alternative scenario that should not be ruled out despite forces elsewhere that are keeping a lid on prices. Certainly, such an outcome could be enough to trigger a broad move higher in bond yields, meaning a sell-off in debt assets whose prices have been boosted by years of non-conventional monetary policy.
These are uncertain times and, as bond investors in Asia, we’re proceeding with caution. Alongside a continued focus on the broader economic environment, we’re sticking to our focus on high-conviction, quality corporate issuers and avoiding the pitfalls that come with chasing yield, particularly at this point of the interest-rate cycle. For us, it’s very much a time to get back to basics.
Victor Rodriguez is head of Asia-Pacific fixed income at Aberdeen Asset Management
