North America: Too Soon to Turn off the Tap

The pace of economic recovery in the US is, at best, softer
than earlier this year but not as precarious as it is in Japan, or regionally
uneven as it is in Europe. The bigger question is about economic sustainability
and that has been clearly answered by the Federal Reserve with its dramatic ‘no
taper’ announcement on 18 September.

Blindsiding most capital
markets, US policymakers refrained from adjusting their US$85bn monthly
bond-buying of Treasuries or mortgage-backed securities (MBS). In doing so, the
Fed cited various reasons from the political standoff on Capitol Hill to
concerns about longer-term interest rates rising. US bond yields have been
backing up ever since Fed chief Ben Bernanke announced last May, under the guise
of better communication and transparency, that reducing market liquidity, or
round three of quantitative easing (QE3), would soon be a part of that equation.

To Bernanke’s credit, he never once suggested a liquidity tightening
event commencing time schedule; the market took it upon itself to price in a
reduction in liquidity in September. Mind you, no US policy member ever went out
of their way to dissuade capital markets that a token taper would commence from
this month.

Any future notion of tapering will, in all likelihood,
become a meeting-to-meeting call once again, beholden to a handful of economic
data points, market developments, and most certainly a safe passage through US
fiscal legislation. The Fed is correct to be hesitant at this juncture however.
Global growth is shaky at best, and turning the liquidity taps too tight, too
soon, would have a huge global domino effect. That probably would not be for the
better if you were listening to the words of the International Monetary Fund
(IMF) chief, Christine Lagarde; the European Central Bank (ECB) president, Mario
Draghi; the Bank of England (BoE) governor, Mark Carney; the Bank of Japan (BoJ)
governor, Haruhiko Kuroda, and the Reserve Bank of Australia (RBA) governor,
Glenn Stevens – to name but a few.

Too Early to Tighten

US
data is proof that there is no need to tighten liquidity just yet. Personal
consumption and corporate spending remains an issue; North American domestic and
global inflation is a non-issue. Cheap credit has yet to consistently filter
through the ‘system’ and promote stronger economic growth. There is no housing
boom in North America, there is a flood of cheaper houses, but the lack of
higher disposable incomes and new jobs are not consistent. Corporations are not
hiring en masse, they are concentrating on increasing productivity and not
spending. Even for consumers the access to cheaper credit has become more
constrictive over the last few years because of tighter regulation.

In Canada last week, the Bank of Canada (BoC) governor, Stephen Poloz, said
that the BoC is waiting for stronger business investments to boost potential
output. Just like in the US, inflation is a non-starter. The biggest threat to
the Canucks’ domestic economy remains household debt, with the debt-to-income
ratio (DTI) rising to a new high of 163.37% in the April to June period. 

The American economy may be heading toward another ‘fiscal cliff crisis
if the US government hits its debt ceiling in mid-October instead of December.
This time, there is no back-up plan. Now that the Fed’s taper decision is out of
the way and Bernanke is pointing a finger at Capitol Hill, a repeat of last
winter’s shenanigans between the Democrats and Republicans are expected to
intensify.   

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