May 19, 2014
Last week: In a data heavy week, it’s hard to imagine that the big news of the week came from the financial markets. And, it was driven not by domestic considerations but what is happening overseas. The backdrop is the continuing tapering by the Federal Reserve. Where it once bought $85 billion in bonds per month, it has tapered down to $45 billion and will be even lower over the next few months. Faced with slow growth in the Euro-zone (or no growth in France, Italy, and the Neatherlands), and very low inflation (which could go still lower), the European Central Bank is thought to be considering its own quantitavie easing program. If the ECB is going to buy bonds, increasing the demand without an increase in supply could well bid up the price (thereby lowering the yield). In anticipation, markets this week lowered yields on sovereign debt, even in France, Italy and the Netherlands. Will the ECB act? Will it more than offset Fed tapering? More importantly, will Euro growth perk up and inflation gradually move up to the ECB’s target of 2 percent? The only thing that is clear right now is that financial markets will be paying very close attention to this story this summer.
The Conference Board Leading Economic Index for the U.S.
The Coincident Economic Index, which tells us where the economy is right now, continued to rise moderately through March. The Leading Economic Index for the United States has been consistently much stronger, suggesting there could be more punch going forward. With the end of inclement winter weather, and some fundamental strengthening in the economy, the growth path going forward looks encouraging. Was that still the signal in the data in April?
Fact of the Week
As the Federal Reserve continues to taper on bond buying, we are also moving closer to the day when interest rates are no longer artificially low. The Federal Government debt totals about $17 trillion. Every inch up on borrowing rates therefore implies higher borrowing costs, possibly resulting in changes elsewhere in the nation’s budget to afford paying the debt service.
Meanwhile, American households are in debt to the tune of about $11 trillion, the lion’s share of which is mortgage debt. But to the extent that this amount is tied to fixed rate mortgages, hikes in interest rates will have less impact on households now, though possibly more impact on those trying to take out a mortgage going forward. Either way, with that much debt to carry, small changes in interest rates can have big consequences – even bigger consequences if the economy were to quickly slide back to a 2 percent growth path. Luckily, the forecast is for something closer to 2.5 percent. And that difference in growth could make the difference in how much negative impact there is coming from higher interest rates, down the road.
Source: The Conference Board
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