Fundamental Analysis of the US Economy:
The last employment report had raised grave concerns as to whether the US economy was losing momentum, but ever since the 35,000 Verizon workers have rejoined work, and now the employment indicators seem to be back on track. On the other hand, the manufacturing sector has been contracting and has grown at a meager rate of 0.8% during the first quarter of 2016. Coupled with this Fed’s Labor Market Conditions Index has been on a decline, which has resulted in the lowering of estimates of job growth rate over the next 12 months. This correlates well with the contracting manufacturing data, which is indicative of an eventual decline in the economy’s growth rate during the coming foreseeable future. Another technical aspect coming into play is the nature of the yield curve, the difference between the 10 and 2-year treasury note yield is smallest it has ever since the economic breakdown of 2008 which is foretelling of a possible contraction in funds available to loan and investors lessened confidence in the immediate economic outlook. Not too far in the past, it is worth mentioning that the flattening nature of the yield curve was a precursor to the 2002 and 2008 recession.
The reason for a contracting manufacturing sector has been the lack of investment, primarily brought about by lower corporate profitability’s. Morgan Creek Capital Management CEO has aptly pointed out that S&P 500 companies’ earnings turned negative just before recent recessions of the past as in 1990-1991, 2001 and 2008 and 2009. This phenomenon has occurred again in 2015 and its implications are unnerving for an economy which has started performing satisfactorily just recently. On a positive note consumer spending has picked up as has the service sector revenue, while unemployment benefit claim starting to recede. The two sectors worth commendation have been the auto and the housing market sector, which have had a positive correlation with stage of the economic cycle and have been continuously performing well which gives rise to the notion that currently the economy is in its boom cycle and has not turned the mound after which the economy can be expected to decelerate. Further an inflation target of 2% set by the FED may be overambitious at a point in time when the commodities market, chiefly crude oil, is trying to make a recovery, even though a full blown recovery is still surely a distant future. Larry Summers, an accomplished economist, is of the view that if history is to act as a guide, then recession should not set in the next three years and there is credence in his observation. For example, if growth was set in from 2012, then the economy would have grown for 5 years, if the slowdown starts occurring in the next 12 months. Thus eventual contractionary cycles may possibly set in within the time frame as postulated by Larry Summers.
The US economy could be hard-hit due to issues outside its locus of control. For example, financial crisis in the 2nd biggest global economy China, which has a heavy reliance on debt financing is creating a leveraged economy which is exposed to collapsing. This in turn can affect not only global trade but specifically the commodity markets can be hard hit. A financial meltdown can ensue brought about by an inability of corporates to pay off debts and the financial contagion would have global repercussions. Also the US presidential elections can put spanner in the works, particularly if Donald Trump is elected. He has campaigned that the $19 trillion debt can be eliminated while keeping fiscal measures unchanged, by an act of refinancing this debt. If this were to occur, we can imagine that the spread between the 2 year and 10-year treasury bill will further narrowed down. This would place the economy at a precipice, empirically peering down to an evident collapse. The current teetering and hitting a near term stall speed when capital investment has dropped appreciably as the economy only grew 0.8% during the 1st quarter of 2016 is not a confidence booster either. The US economy now lies at a sensitive juncture and any oversteering by the FED could be a mistake and it should wean away from strongly enacting the 2nd interest rate hike aggressively which could thrust the economy into a stall motion.
If a recession scenario were to emerge, it would surely be a big setback for the sentiment for the general populous many of whom may still be sifting their lives from the impact of the 2008 economic collapse. With not many tools in the bag, the FED could deploy an expansionary fiscal policy, which could entail either public spending projects or tax cuts, but policy inception and deployment would be a complex phenomenon and may just add to the despair of the people who are still reeling off the effects of the fiscal policies, as necessary as they may have been, of the Obama led government.