What’s the biggest risk to the US economy?
Discusses global markets and the dollar’s spike
The june payroll number was a blowout at 222,000 new jobs and a 4.4 per cent unemployment rate, exactly the rate on July 2007, the peak of the credit bubble. While 222,000 new jobs is significantly above the Street consensus, the Bureau of Labour Statistics also revised up April and May payrolls by 45,000. Average hourly wages at 0.2 per cent were not a sizzler but this is entirely predictable in a US economy where trade unions have been decimated and robotics/automation/e-commerce reconfigure entire industries. The June jobs data makes another Fed rate hike in 2017, three rate hikes in 2018 and the shrinkage of the Federal Reserve’ $4.5 trillion balance sheet highly probable. Ray Dalio is dead right. The era of postLehman central bank easy money is definitely over.
There is now a “Goldilocks” dimension to the US economy. GDP growth in 2017 could well be 2.5 per cent despite the low conviction on the prospects of Trump’s tax reform and fiscal stimulus agenda being enacted in Congress now that the Republicans have failed to “replace and repeal” Obamacare.
Since the Yellen Fed believes the weakness in inflation is “transitory” and the Philipps curve is no fairy tale, the US central bank will continue to tilt towards the “normalisation” of interest rates. So it is entirely rational for the yield on the ten year US Treasury note to rise by 30 basis points to 2.39 per cent after the last FOMC, Draghi’s hint of a ECB taper and now the robust June payroll data. The collapse of gold prices to $1,210 an ounce and crude oil to $44 West Texas tells me that the commodities complex is now pricing in an ugly endgame to Fed tightening.
However, if the Federal Reserve implements its dot-plot projections, I see no reason why the overnight borrowing rate could not rise to 2.25 per cent and the 10-year US Treasury note yield rise to 2.90 per cent by next summer. I can easily envisage three-month London Interbank Offered Rate trade at 2.50 per cent by next summer. This will be the kiss of death for the world’s debt and property markets. Is this scenario priced into current asset prices worldwide? Absolutely not. As the world’s most powerful central banks brace to throttle the world’s liquidity pump, financial markets could well see this summer of love, of leveraged speculation and ultra-low volatility, disappear as the macro storm clouds darken.
As I watch the black masked anarchists and anti-capitalism protestors clash with the German riot police in Hamburg on television, I see a visual metaphor for the political and economic fissures that could well kill Mr Market’s sunny optimism. The US stock market peaked amid such a “greed is good” milieu in October 2007 and October 1987.
Even though the US is in a latestage economic cycle, there is no imminent risk of recession, the reason credit spreads in the corporate, high yield and emerging debt market have not gone ballistic. The absence of wage growth despite full employment makes the Federal Reserve pause if geopolitical risks escalate. The stock market is expensive rise in Citigroup shares during the past month but its leaders are now financials trading just above book value, not dotcom startups without revenues or earnings or even FANG. The Italian bank bailouts, the Greek IMF deal and a reformist French President in the Elysee Palace has slashed political risk in Europe. The Russell micro-cap index just made an all-time high. The yen has depreciated to my 114 target against the US dollar. The shortterm auguries on Wall Street tell me that the summer rally in the US stock market will continue in July and August. North Korea? There will be no hot war. The Pyongyang regime will go eyeball-to-eyeball with Uncle Sam but, like Nikita Khrushchev in Cuba, ultimately blink at the moment of truth. The biggest macro risk I see is an unexpected inflation insurgence that forces the Fed to accelerate its pace of rate hikes.
Interest rates are the life blood of the financial markets. I expect the US Treasury yield curve to steepen — the reason JPMorgan, Bank of America and Citigroup are up 1012 per cent in the past month. The euro rose to 1.14, not far below my 1.16 target. I am less sanguine on the British pound at 1.30 as the skies darkens above Westminster and the High Street!