A multispeed world
Posted on 20 November 2014
"The picture in Continental Europe is sharply mixed."
The notion of a “two-speed world” is coming closer to fruition, judging from data released in the United States and Continental Europe. In the US, employment levels have surpassed the peak of the prior expansion. Claims for unemployment benefits rest at 14-year lows.1 The unemployment rate at 5.9% is at a level last seen six years ago. Average hourly earnings continue to grow roughly two percent over prior year levels – approximately in line with the inflation rate2. Job openings, an important gauge of economic vitality, are at levels not seen in 13 years3. Add to this falling energy prices and a stronger dollar, it suggests a future that consumers will do what they do best: consume.
The picture in Continental Europe is sharply mixed. The exertions of the European Central Bank (“ECB”) are in response to a recessing inflation rate that strikes fear into the heart of any sentient central banker. The ECB is not alone in its quest to arrest falling prices brought about by anaemic but improving economic growth and elevated unemployment. Sweden’s central bank, the Riksbank, cut interest rates to an absolute level of zero percent – a first for the central bank. Within the euro zone, the economy continues to struggle to gain forward momentum. Growth in Germany and France, the two largest economies in the bloc, is slowing or absent; however, in the periphery where the bitter medicine of internal devaluation has been taken over the last several years, green shoots are attempting to sprout.
Equity markets in these blocs reflect the economic conditions in which they reside. Euro zone equities viewed through the Euro Stoxx 50 Index have recovered less than half of the correction that started in mid-September, while the S&P 500 Index has recovered more than 80% of the sell-off4 Investors are voting with their respective currencies. Confidence is translated into prices.
Is the present prologue for interest rates and central bank policy?
Not likely. Just as there is an economic divergence between the US and Europe, there should be a divergence in central bank policy. In the case of the Federal Reserve, it is increasingly difficult to argue for continued quantitative easing as the CEO and President of the Federal Reserve Bank of St. Louis, James Bullard, hinted earlier this month. Beyond the clutch of data aforementioned, the unemployment rate at 5.9% is below the OECD’s (Organisation for Economic Co-operation and Development) estimate of what the Non-Accelerating Inflation Rate of Unemployment (“NAIRU”) is for the United States: 6.08%5. It is a tough task to justify continued extraordinary monetary policy to ignite growth, when the economy is operating in an area that raises the risk of inciting inflationary pressures. To be sure, NAIRU is the economic equivalent of the Yeti – often cited but never seen. The point remains that the days of easy money in the United States should be numbered.
The tripartite solution
Europe’s path will be a familiar one if executed properly. Getting to a durably healthier footing will require a tripartite solution, which involves extraordinary monetary policy from the central bank; fiscal stimulus programs from the public sector; and finally, a willingness of the polity to engage in labour and market reforms. The efforts of the central bank should “buy time” for the latter two elements of the solution to take form. To be sure, this is easier said than done. Moreover, the principal players in this solution, Germany and France, have not shown a willingness to constructively work toward an enduring solution. Adversity is the mother of invention. Given recent developments within the euro zone, a renaissance of innovation might be in the offing.
Read more in our full November edition of Compass [PDF, 1.2MB].
1 Source: Bloomberg, as of October 25, 2014.
2 Source: Bloomberg, as of September 30, 2014.
3 Source: Bloomberg, as of August 31, 2014.
4 Source: Bloomberg, as of October 29, 2014.
5 Source: Bloomberg, as of October 29, 2014.
Hans Olsen, CFA Global Head of Investment Strategy