Monday, 13 May 2013

Clearly opaque...

Today saw the release of US retail sales which were better than expected. The good news was broad, suggesting that lower commodity prices and higher house prices are providing enough relief to consumers to counter the higher taxes and lower fiscal spending they are suffering.

There are signs, therefore, that QE is not just providing liquidity to keep asset prices afloat (as a disturbing amount of press speculation has asserted recently). We can see fundamental evidence to support the logic that lower mortgage rates mean higher disposable incomes.

We have frequently discussed the underlying strengths of the US consumer (driven by positive wealth and income effects) and the manufacturing sector (driven by the shale gas revolution). The tentative evidence of today’s retail figures is that these forces may be stronger than we had thought.

In addition to today’s retail sales we have industrial production, housing numbers and the Empire manufacturing survey due this week. These will be closely watched because the question of when the US will unwind its monetary stimulus continues to loom large over the markets.
Source: Bureau of Labor Stastics/Census Bureau
Last week the Wall Street Journal polled economists and found a slim majority expecting the pace of purchases to be reduced during this year. We, however, expect it to continue unchanged. The main threat to our thesis is not the fall in the unemployment rate (as this reflects a falling participation rate rather than tightening labour conditions). Instead, we see the signs of excess in certain parts of the credit market - the boom in single B high yield bond issuance - as the main factor that might give policymakers cold feet.

Nevertheless it seems the Federal Reserve is planning an exit strategy and while the timing remains uncertain we understand that its committee members plan to reduce the pace of purchases somewhat erratically to prevent the market from positioning ahead of policymakers by, say, quickly shorting treasuries and MBS. In short the communication point that the Fed will be looking to put across to markets will be that speculators will not be able to predict the pace at which stimulus will be withdrawn.

An initial token reduction in pace would be a sensible way of implementing this strategy. Otherwise, should inflationary pressure build, or employment soar, or the dollar collapse, the Fed could be forced to slow purchases fast, in which case there would be little that could be done to persuade the market otherwise.

Life after QE?

To be clear, we don’t think those things will happen. We expect that sequestration, the mandated cuts to US federal spending, will be enough to keep inflationary pressures muted and employment growth tepid for the rest of this year. Today’s retail sales figures provide a modest challenge to that thesis, but still not one which would hint that monetary policy is too loose.

Guy Foster
Head of Portfolio Strategy

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