Tags: Euro | US | Fed | taper

Good News for US Won't Necessarily Be Good News for Everybody

By Tuesday, 10 December 2013 10:31 AM Current | Bio | Archive

As we are closing in on 2014, we should be feeling good since most of the 2014 forecasts paint a somewhat better global growth/recovery with the most robust growth to be expected in some major advanced economies while growth in the emerging economies should remain moderate. As always, we'll have to wait and see what happens.

The latest Organization for Economic Co-operation and Development (OECD)'s composite leading indicators, shows signs of an improving economic outlook in most major economies.

It's interesting to take notice the United States continues (constantly) to grow around trend (Fitch expects "real" growth in the United States at 2.6 percent in 2014 and 3 percent in 2015, and unemployment to decline further to 6.9 percent in 2014 and to 6.5 percent in 2013); Japan is growing above trend; the major five economies of Asia, which are China, India, Indonesia, Japan and Korea, all show a "tentative positive change" in momentum; and the euro area signals an "uneven" but nevertheless positive change in momentum, with Germany far ahead of the pack of the 17 member states of the euro area.

We hear a lot of positive expectations about the recovery in the euro area, I'd prefer to let everybody decide for themselves if the euro area economies really have the necessary fundamentally sound foundation for accelerating growth in the foreseeable future.

That said, nobody can deny the fact that the latest euro area GDP growth numbers have shown only some fragile improvement, as the growth came in at +0.1 percent in the third quarter from the second quarter and GDP growth remained negative at -0.4 percent compared with the third quarter of last year. In addition, Italy (-1.9 percent), Spain (-1.1 percent) and Greece (-3.0 percent) continued to contract for the third quarter of 2013 compared with last year's third quarter.

In the meantime, unemployment in October remained stubbornly high in the euro area, at 12.1 percent, while youth unemployment rose another 15,000, which doesn't take into account all those who left their countries in search for work. The highest youth unemployment rates were in Greece (58 percent), Spain (57.4 percent) and Croatia (52.4 percent).

The biggest non-euro area country in the European Union, the United Kingdom, had a 1.5 percent GDP growth rate in the third quarter from the year before, and Fitch expects it to grow further at 2.3 percent in 2014 and 2015.

In the United States, as a consequence of the recent better job data and other good indicators, Federal Reserve speakers were doing their very best to prepare investors for the coming tapering of bond purchases by the Fed.

It's interesting to take notice that even the normally "dovish" Federal Open Market Committee voting member James Bullard, President of the Federal Reserve Bank of St. Louis, was sounding quite bullish when saying: "Recent labor market results seem to suggest that coming months will show continued labor market improvement. . . . Based on labor market data alone, the probability of a reduction in the pace of asset purchases has increased."

For the time being, I can't detect any indicator that hints unemployment is on the brink to reverse its downward course. I think I can say we are closing in rapidly on the date the Fed will start tapering its bond-buying program.

In this context, it might be interesting to take notice UBS said they are quite bearish on price developments in 2014 of high quality sovereign bonds like U.S. Treasurys and German bunds as a result of the Fed to start tapering its $85 billion monthly asset purchases.

Remember, lower bond prices mean higher yields. This also means that the long-term investor who has in portfolio of longer-term, high-quality bonds could have a choice to make the decision in the near future whether they will keep these longer-term bonds in their portfolio or sell them in order to buy them back at a later date, while in the meantime parking the money in safe short-term cash equivalent instruments. Again, this could work out rather well if yields move higher. Of course, everybody has to decide for themselves alone.

Yes, such a transaction would be something like a "first-sell-and-then-buy-back later" operation. Keep in mind, the 10-year Treasury yielded 1.6255 percent with a price $133.67 on May 2 this year and closed at 2.8389 percent on Dec. 9 with a price of $124.43, which was a drop in price of 6.91 percent in seven months and a rise in yield of 121 basis points, which should for many long-term investors be important enough to take notice of.

Finally, I think it's also important to keep an eye of some of the risks that are still out there. Besides the geopolitical risks (e.g., Iran/Israel), I think one of the most important risks is the euro area could act too late to head off deflation.

Please take notice the euro area producer price deflation now stands at its highest rate since December 2009, while the latest retail sales numbers fell (unexpectedly) in October. Maybe the most worrying of all, loans to the private sector shrank by 2.1 percent year over year in October, the biggest drop on record, according to the European Central Bank.

And if all that wasn't enough, the banks operating in the euro area periphery still have a mindboggling $2.06 trillion to $2.75 trillion "non-performing" loans on their books. As these periphery economies still don't grow at rates that should be in the neighborhood of 3 to 5 percent, any long-term investor should ask himself who's going to pay for that still-ongoing mess with no solution in sight.

If you ask me, yes the euro area problems in the periphery are far from over, and that fact by itself alone could still derail the whole euro project.

And then there is still a possibility, albeit rather low, we could see a "global" chain reaction in most places on the globe as a result of the Fed starting to taper.

So, fundamental good news for the United States won't necessarily be good news per se for everybody. Long-term investors should be prepared that the good news, whenever that comes, doesn't mean bad news for their investments.

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As we are closing in on 2014, we should be feeling good since most of the 2014 forecasts paint a somewhat better global growth/recovery with the most robust growth to be expected in some major advanced economies while growth in the emerging economies should remain moderate.
Tuesday, 10 December 2013 10:31 AM
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