Bond Outlook by bridport & cie, October 3 2012

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Stagnation or slow growth everywhere in the West, but a little optimism about UK employment may be justified. How can jobs grow by the GDP stagnate? Mystery!

Europe has now entered a period of relative respite in which political “leaders” (we put the quote signs as they scarcely merit the appellation) must put into effect the grand plans to mutualise debt, build a banking union and establish a federal system of economic governance. Will they do it? Probably, but slowly, hesitantly and only as financial markets create crises big and small to urge then along.

 

Moreover, if and when growth returns to Europe, it will be modest. In fact, it is and will remain modest throughout the West. This slowness is the reason quantitative easing has been possible without creating inflation. If ever the serious growth did return inflation would take off (even now in Europe is above central banks’ targets). QE can only keep economies ticking over; it cannot lead to serious growth.

 

Almost five years ago we foresaw a drop in GDP followed by years of slow growth due to deleveraging: a simple and homely economic observation that spending beyond one’s means makes inevitable a period of belt-tightening to return to a balance of income to expenditure. More recently we reported on analyses which explained that ageing populations consumed less than families with children at home and that Japan gave a perfect example of age-induced stagnation. Now there is a third argument presented by Martin Wolf of the FT but based on work by Robert Gordon of Northwestern University. The current pace of innovation is far slower than that of the British industrial revolution or the generalisation in the 20th century of running water, sewerage electricity and labour-saving devices. Most of today’s internet related innovations having already had their effect.

 

Gordon’s arguments are not entirely convincing, not least because innovations remains the great advantage of Western economies and even management literature mow stresses such concepts as building an “innovation culture” in enterprise. In fact, two additional but secondary observations by Professor Gordon may be more significant than his dismissal of current innovation. Women have now moved into the work force, which can no longer grow from that source, and educational attainment is levelling off.

 

Growth in the West will be very slow with correspondingly low returns on all sorts of investment security. In fact, Bernanke has now gone official in stating that he wants stock price and housing inflation, but apparently only at modest rates of 2 to 3%. It is a long way from the “Greenscam put”!

 

Can we find positive news anywhere to give a silver lining to this dark cloud? Actually, we can, and, of all places, it is the UK. If The Economist is right, and despite all the poor data on GDP growth and inflation, the UK shows “tentative signs that the economy is stirring”. The main evidence lies in the employment rate. Job creation in the private sector is exceeding the loss of jobs in the public sector, and the pace of job creation is accelerating. This contrasts strangely with the USA, which is combining slow economic growth with dismal job creation, whereas the UK has an allegedly stagnant economy and high job creation (and it is not from government “make-work” jobs as in France!). We cannot explain this phenomenon. The mystery may emerge as various pundits look into whether The Economist’s moderate optimism is justified and explicable.

 

We are grateful for the silver lining!

 


Macro Focus

United States

 

The economy expanded 1.3% from April through June after growing at a 2% rate in the first quarter. Household purchases rose at a 1.5% annual pace last quarter, the slowest in a year.

 

The ISM Manufacturing index expanded in September from 49.6 in August to 51.5, indicating the industry is stabilizing after three months of contraction.

 

The average mortgage rate for a 30-year fixed loan declined to record lows (3.4%) as the Federal Reserve pushed down borrowing costs by resuming purchases of mortgage-backed securities. However, the number of pending sales of existing homes dropped 2.6%.

 

Euro Zone

 

Surveys still pointed down. PMI Manufacturing index has contacted for 14 months (46.1 in September) and economic confidence dropped to 85. The unemployment rate in the euro area reached 11.4% in August, the highest on record.

 

Euro-area inflation accelerated to 2.7% in September after the Spanish government increased sales tax to help plug its budget gap.

 

Iceland is targeting joining the euro area as the only option after phasing out capital controls

 

United Kingdom

 

The economy shrank by 0.4% in the second quarter, less than previously estimated, and disposable incomes rose the most since 2009.

 

While the PMI Manufacturing fell to 48.4 from 49.6 in August, the GfK consumer confidence index rose to minus 28, a 15-month high.

 

House prices fell for a third month in September. Prices declined 0.1% from August and 0.5% from a year earlier.

 

Switzerland

 

KOF economic leading indicator increased for an eighth straight month in September. The monthly gauge rose to 1.67 from a revised 1.59 in August. However, the PMI Manufacturing index fell to 43.6 from 46.7 in August.

 

August real retail sales rose 5.9% in a year.