Weekly Economic Commentary • Principal Global Investors
Covering the week ended April 25, 2014 — Published on May 1, 2014
No Spring Swoon This Year
While the winter doldrums have not yet dissipated across all economic sectors (especially still-soft U.S. housing data, more fully discussed later), positive sentiment has returned to the job market. Recent issues of Economic Insights have provided details on the improving data in the labor market, and the consensus for April payroll employment gains is quite favorable, being above 200,000. If that happens, it will simply reinforce the view that there will likely not, unlike past years, be a spring swoon this time around — and indeed that an upshift is in the offing for the U.S. economy despite what was likely a soft first quarter of GDP growth (that data due out on April 30). Strong April jobs data would also likely reinforce the expectation that the Federal Reserve (Fed) will stay firmly on its current glide path of $10 billion in a third round of quantitative easing tapering per Federal Open Market Committee (FOMC) meeting.
But the expected economic upshift in America is certainly not guaranteed and will rely on several factors beyond just single-family housing regaining its footing. Personal consumption's contribution to the economic recovery will be critical given the large proportion of the economy it represents. Consumer confidence surveys are improving but remain somewhat mixed, perhaps themselves a function of the aftermath of winter weather and relatively high gasoline prices, which have seen a slow but steady upward march thus far in 2014. And personal savings rates remain relatively high (by U.S. standards) as the memories of the global financial crisis have not fully dissipated despite a more than complete rebound in household net worth.
Indeed, from a macro-financial perspective, consumers are in excellent shape to expand their spending and borrowing. Aside from student loans and auto loans, household deleveraging is still the norm and debt-service burdens are extremely low. Further, the banking system is, in contrast to Europe, largely restored such that if consumers wanted to increase borrowing to finance higher levels of spending, they certainly have room to do so. Separately, if home mortgage rates remain low and can provide further support to the housing market, it should also boost durable-goods retail sales through the follow-on effect of appliances, electronics, and home furnishings.
The business sector, despite now having reached record private-sector payroll employment, also needs to step up its activity and get past the high level of caution that has thus far constrained spending and investment. It is true that real business fixed investment levels have finally moved above their pre-global financial crisis peak, but just barely at 1.2% higher; that stands in contrast to total real GDP, which as of year-end 2013 was more than 6% above its prior peak. The large build-up of cash reserves in corporate America, albeit somewhat concentrated in the hands of a relatively small number of very well-capitalized companies, does represent another source of firepower if businesses are willing to unleash it. Further, in contrast to households, nonfinancial business leverage has increased, as businesses have taken advantage of low interest rates to increase long-term debt. Principal Global Investors forecasts that over the course of 2014 and 2015, the aforementioned gap will close, with expected real growth in real-business fixed investment of 6.6 – 6.7% each year, compared to average GDP growth of about 3% per year over that same time period.
North America and Europe: The Other Decoupling?
Past issues of Economic Insights have referenced the changing dynamics confronting near-term global economic growth, comprising a decoupling theme. More specifically, emerging markets (despite their still favorable long-term economic outlook) are unlikely to be a source of strength for the global economy in 2014 or perhaps even 2015, with developed economies instead leading the way. The latest projections from the International Monetary Fund (IMF) bear that out. While their recent global economic growth downward revision for 2014 and 2015 overall was modest, it was mostly attributable to down-rating emerging and developing markets. For example, the IMF revised down 2014 real GDP projections for Russia (down 0.6% from prior estimate), Brazil (down 0.4%), emerging and developing Europe (down 0.4%), South Africa (down 0.5%), and Mexico (down 0.5%). Somewhat curiously, however, projections for China and India economic growth were left unchanged by the IMF.
The only developed economy whose growth estimate was revised downward was Japan, whose forecast for 2014 declined by 0.3% from prior IMF projections. But that doesn't imply that all other developed economies are out of the woods. Europe is headed out of recession but it should be noted that many Eurozone nations are still years away from growing their absolute real GDP levels back to prior peak.
U.S. Commercial Real Estate: The Weight of Capital
As noted earlier, single-family residential has experienced a bumpy few months. But not so for U.S. commercial real estate, which is seeing strong capital inflows into virtually all sectors of its public and private debt and equity quadrants. Even the publicly traded Real Estate Investment Trust (REIT) market has mostly recovered from its 2013 downward price correction, having generated a total rate of return year-to-date of close to 13%, well ahead of the broader equity markets. The relatively high dividend yield on REITs along with continued low Treasury rates have certainly helped. Earlier market concerns that rising Treasury rates could result in downward price corrections in underlying commercial property values has led to a major change in REIT correlation patterns. Typically rather highly correlated with the stock markets over the near term, publicly traded REITs have over the course of the past couple of years instead become much more highly correlated with the bond market.
Separately, Commercial Mortgage-Backed Security (CMBS) issuance is likely headed for its highest year since the global financial crisis, with consensus estimates that U.S. issuance will top $100 billion in 2014. Commercial real estate sales transactions are also likely to have their strongest year since the global financial crisis, perhaps reaching $400 billion as both domestic and foreign capital seeks additional commercial real estate investments. Real estate lending activity remains very active, and in fact is one of the key exceptions to otherwise constrained lending activity by commercial banks. Banks are highly competitive with life insurance companies, private debt funds, and CMBS, although do remain quite disciplined in terms of construction lending, at least for the moment.
Data and Geopolitical Issues Roundup
U.S. core capital goods orders increased 2.2% month-over-month. Shipments of core capital goods increased for a second month in a row, up 1% month-over-month. The weekly Bloomberg consumer comfort index increased to -25.4, the best reading in eight months. Jobless claims increased by 24,000 to 329,000. However, seasonal adjustment in the weeks surrounding the Easter holiday is typically pretty volatile and therefore hard to read much into the increase in claims.
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