Investors worldwide face two looming uncertainties. The first is when will the US Federal Reserve begin to turn off the taps on its US$85 billion a month monetary stimulus programme?
The other nagging worry is the risk of a repeat of the fiscal crisis that partially shut the US federal government in October.
Combined, both events are likely to influence whether the fragile global economic recovery gains strength or shatters.
Here, Robert Baur, the managing director and the chief global economist for Principal Global Investors, a US financial company with US$289.1 billion in assets under management, gives his views on both risks.
What is the outlook for the US economy?
The economy is a doing pretty well. We’re probably growing at a 2.25, 2.5 per cent rate right now, which is a little faster than the average of the past three or four years. The economy is solid, resilient and we have slow and steady progress. We do expect a little pick up in growth into next year. We did expect it this quarter but the fallout from the [US government partial] shutdown is hurting confidence. We think the pick up to 2.5 to 3 per cent growth is maybe delayed to the second quarter of next year. We think we can see above-trend growth for maybe a year or so. In addition, as the cost competitiveness of emerging markets has diminished quite a bit because of fast-growing emerging markets over the past decade we will start to see manufacturing move back to the US, which is very positive. It’s also hard to underestimate the positive impact of the shale oil and gas boom in the US.
Janet Yellen will take over from Ben Bernanke as the Federal Reserve chairman from February 1. How will the change affect Fed policy?
I don’t think there will be any particular change in policy. The consensus now is centred on a March timeframe for reducing bond purchases or the pace of them. It does sort of make sense. Why would they do something a week before Christmas and then the January meeting is still [Mr] Bernanke’s and the period after that is still the transition? So the March timeframe is still most likely. But I wouldn’t discount for something to happen in January. [Mr] Bernanke might want to start under his watch.
How will markets react to the end of quantitative easing (QE)?
They didn’t react well in May and June and July, August, when the Fed said it was slowing bond purchases. Interest rates shot up and spreads shot up on high-yield emerging market debt. When the Fed slows the pace of bond purchases it reduces the pace of additional liquidity to the world and that does in some sense have a slight tightening affect. But over the summer investors had become too exuberant about emerging market rates. There was tremendous issuance at that time and that was probably overdone. I don’t think we’ll see that sort of market movement again but if we do have a pick up in interest rates in the US, even mild as we suggested, interest rates will rise generally. That rise will be difficult for emerging markets and we’ll see less liquidity in the system. I don’t think we’ll have quite the collapse in markets and bond purchases we had in the summer.
Do you forecast an exit of cash from the Middle East, Asia and other emerging markets when the Fed begins to taper QE?
I would put that down less to tapering and more to the fact the US economy is becoming viewed around the world as stronger and more resilient than people thought. With some manufacturing coming back to the US because of less competitiveness in emerging markets the flow of capital back to the US will result in higher interest rates, a stronger economy and better prospects.
The other big uncertainty on the horizon is the US budget debate, likely to re-emerge ahead of January 15, the date when temporary government funding expires. How worried are you about this?
I don’t see another government shutdown. I think it’s January 15 when the continuing resolution runs out. I think we’ll get something worked out by then. Immediately after that compromise deal was signed, policymakers sat down and started working out a budget. I think they’ll come up with something. A key problem for the Republicans was administration and Democrats wanted higher revenues, higher taxes. I think I’ve read between the lines that the administration is backing off that necessary and Republicans are willing to trade sequestration cuts for other cuts. I guess I think a budget compromise will be reached.
Will this be a long-term solution?
This will be a stop-gap measure for maybe through the election next year as neither party want a big standoff before the election. At the root is a very large ideological struggle between the group that wants larger government and the other side that believes the government is playing too big and reducing incentives.
Do you think investors in US Treasuries and other debt will at some point move their money elsewhere?
At some point markets are going to worry US debt has got out of control if the build up of US debt continues at the pace of the last three or four years. But I don’t think that’s an issue for now or next week, I think it’s an issue for 2016 or 2017.
Do you think the US government is more concerned about reviving growth than cutting federal debt?
At some point there will have to be a reduction in out year increase in entitlements as that’s the real driver of federal debt and expenses at the moment. It doesn’t appear we will get the kind of budget resolution today that will lower those entitlement expenses three or four years ago. At some point, markets will respond negatively to the issue of more debt. At some point the bond vigilantes will come back and force government cuts.
tarnold@thenational.ae