Capital Markets

By Louis S. Barnes                                  Friday, January 3rd, 2014
Last week’s look-ahead column closed with passing mention of surprises. As the world will not truly re-open until next Friday, January 9 with release of December job data, today we’ll explore the potential for one domestic surprise, and three foreign oops-a-daisies. The more the four tilt toward oops, interest rates will fall; the more they improve, rates up.
My domestic opinion has survived the week: headwinds are lighter than any time in a decade. That said, tailwinds are also lighter, especially good, ol’ cyclical recovery. In the aftermath of the Great Recession neither jobs nor housing have behaved as they “should,” and the stock market rally may be more QE artifact than GDP anticipation.
Disparate observers (Tim Duy, U of Oregon; Rick Reider, Blackrock) have noted recent changes in the Fed’s estimation of the job market. A four-year puzzle: a steady decline in unemployment, but a nearly equal decline in participation in the workforce. If unemployment really is falling, competition for workers will cause wages to rise and ultimately turn inflation upward. Bernanke in December: “Inflation can be quite inertial. It can take quite a time to move. I think a lot of the declines in the participation rate are demographic or structural… a lot of the unemployment decline that we’ve seen, contrary to sometimes what you hear, I think a lot of it really does come from jobs.”
Tha-dump. That’s the most optimistic forward by the Chairman since the show stopped. Bilateral surprise potential: 1) cyclical growth pressure has been low, but is now stronger than we’ve thought, or 2) job growth looks like cyclical pressure but isn’t. Down the first road the Fed is eager to end QE for fear it may have to tighten sooner than anyone thinks; down the second, global forces have made obsolete the cycles of the last 65 years, and the Fed may not have done enough. Or be able to.
Japan is everyone’s “bug in search of a windshield.” Its national debt is at least double its GDP, and it has entered last-ditch emergency policy. The Bank of Japan is buying Japanese bonds at about 2.5 times the rate of the Fed’s QE, trying desperately to ignite the economy, and in April Japan will attempt the simultaneous feat of austerity, raising the national sales tax from 5% to 8%. Yesterday the Health Ministry (often less than frank) announced a 244,000-person decline in Japan’s population, an annual affair since the crest before 2010 at about 128 million. Rather worse than a 2% annual shrinkage: most of us get a lot older before we die and become a drain on tax revenue. Good news and bad news: Japan’s life expectancy is the longest anywhere.
All of that notwithstanding, 95% of Japan’s debt is held inside Japan, and so long as Japan’s people will accept the yen printed by the BoJ… no big surprises. Internationally the yen fell 25% last year, undercutting the exports of its competitors (everybody).
Europe’s thin pulse is getting great press. Presumably because treading water is so much better than drowning. Re-elected Angela Merkel’s first demand of the others: surrender control and tighten austerity (Nicht Schwimmen!). The ECB: if anyone bets on drowning by shorting Club Med bonds, we will throw a life-preserver. But not until they are drowning. Nothing has changed: Germany’s surplus, peripheral unemployment and debt growth; economic, fiscal and banking disunion. Europe’s people are second-oldest only to Japan, adding to the impossible fiscal situation (Europe does allow immigration, stabilizing population; Japan is 98.5% Japanese). As big as Europe’s debts are, only about half of Japan’s GDP percentage, and most is owed in-country.
China is attempting to rebalance from fast-expansion over-investment to a normal economy, and nobody there or anywhere knows how it will go. Its politics are so different from any other economy that no one outside even knows how to keep score. The US Army is not in business for itself. Our political parties do not run our judiciary. We do not plan quickly to move 400 million farmers without other skills to new cities. We spy on civilians, but you can write or speak as you wish. Bet on one thing: a China consensus values stability. Xi Jinping will not be China’s Mikhail Gorbachev.
Overseas surprises are not imminent, but if they were, they wouldn’t be surprises.