August Economic Outlook
This is a monthly newsletter by Greg Sweeney, CFA, Chief Investment Officer, at Bell State Bank & Trust. Sweeney holds a bachelor’s degree in business from the University of North Dakota, is a CFA charter holder, and is a 25-year veteran of the Investment Management team.
Federal Reserve Monetary Policy
- At the Federal Reserve meeting on August 9, the Fed continued to express concern for the slow rate of growth compared to the economy’s potential. As expected, the Fed is leaving the Fed funds rate between zero and 0.25%.
- The year-over-year consumer price index (CPI) remains at 3.6%. The monthly report showed CPI decreasing -0.2% even though housing, which is measured by the “rent equivalent,” is rising and makes up the biggest allocation in the index. We don’t expect to see the near-term CPI above 3.6%.
- Our May outlook called for a 98% probability the government would raise the debt ceiling. Why? Because the U.S. is in no position to default (or pay off) on its debt. The issue is at rest for now, but it likely won’t even be 2 years before it again becomes a current topic.
- It is easy to see why people in Greece were so angry about their debt and the subsequent austerity plans. In short, the debt level of the country was hidden by politicians using complex derivatives and interest rate swaps for nearly 10 years. In the U.S., the problem is in plain sight, but a large contingency of voters don’t follow the revenue, expense and debt developments of the federal government, and political courage to address it is in very short supply. To help put the magnitude of the U.S. debt situation in perspective, the debt of the U.S. government is about 7 times annual tax collections. That is similar to having credit card debt 7 times higher than our annual income.
- Take a look at www.fms.treas.gov/dts, a two-page report produced daily and tracking revenue (taxes) and expenses of the federal government. Spend about 15 minutes familiarizing yourself with the report the first time and then look at it occasionally. The rate of U.S. financial degredation is startling. For projected budgets, take a look at www.cbo.gov. There is a summary version of the 10-year revenue and expense forecast. This is also a good reference, but forecasts regularly underestimate actual deficits.
- At some point the academic economists in Washington need to set down their Keynesian text books and look at the real world to see that the elephant in the room is jobs.
- The return after inflation for the 10-year Treasury continues to go downhill. With inflation at 3.6% and the 10-year Treasury bond yield at 2.5%, investors lose more than 1% per year to inflation before even paying taxes.
- What is this saying? Normally it indicates fear about the future prospects for the economy, suggesting that growth may be limited and inflation will go lower. In this environment, it is harder to distill all of the competing forces. At present, most of the developed world is struggling with excessive debt. The U.S. may be the safe haven. Not because we don’t have problems; we are just like the rest of them. To reuse a phrase coined during the subprime mortgage fallout, we are just the best-looking pig because we are the one with lipstick.
- As interest rates go lower, this environment makes it difficult to deliver on our fixed income philosophy of delivering a positive return every calendar year.
- Second-quarter earnings were fine. Stocks are having a tough time as the data on manufacturing, personal spending and consumer confidence suggests the prospects for growth have retreated to some degree.
- In the absence of psychological constraints that go with declining stock markets, valuations of stocks appear to be better than valuations of bonds.