Global investors were dealt a fresh blow following the Federal Open Market Committee (FOMC) meeting in mid-May. With one word, Ben Bernanke rattled markets by citing the possibility of an end to its asset purchase programme that was just too close for comfort.
Equities, commodities and fixed income markets all witnessed broad-based negative returns with very few places to hide. Fixed income markets fared the worst. The 10-year US Treasury yield hit an intraday high of 2.66 per cent in the five weeks that ensued, from a low of 1.61 per cent on 1 May, the highest level in almost two years.
The failure of traditional policy tools to spur the global economy forced central bankers to embark on, by their own admission, an uncharted course known as quantitative easing. Anchored by its dual policy mandate, the Federal Reserve deployed its last remaining weapon, the purchase of securities in the open market.
With $85 billion in monthly purchases, the policy making body believed financial institutions would be plush with cash, driving reinvestment in stocks, commodities and other risk assets. The price appreciation from increased demand should create a wealth effect, encouraging households and businesses to spend and spur demand for goods, services and other private investments. The end result, the Fed hoped, would kick the economy into a sustainable operating cycle.
While asset prices rose to unprecedented levels, there were many headwinds at work to negate the wealth effect. One of the difficulties of this somewhat novel idea was failing to effectively influence the willingness of banks to lend and creditors to borrow. Much of the proceeds from the sale of treasuries and mortgage back securities remained on members’ bank accounts at the Federal Reserve as banks struggled with a prolonged ailing economy and tougher regulations. Faced with higher taxes, uncertainty in their employment prospects and very early stages of a housing recovery, indecisive American consumers are sitting on the fence.
The improvement in US unemployment from over 10 per cent at the height of the crisis to 7.6 per cent is quite significant. Given these results, is it reasonable to expect quantitative easing to continue to infinity? And why did markets swoon in the face of the chairman’s remarks when his committee has been vocal in their concern on the accurate timing of an end to easy money policy?
Could the answers lie in the market’s expectation of what the recovery should look like? Perhaps this time around, the face of the recovery will look very different from the past. Although the central bank has not cited a full employment rate, recent discussions suggests a range between 5 and 6 per cent, a gain of an additional 3.2 million jobs. Even at this perhaps conservative 5.5 per cent natural rate of unemployment, millions of Americans will still be out of work. Can the world’s largest service-driven economy maintain sustainable grow without jobs?
The pace of job recovery post the 2007 credit crisis has been unusually slow. Some data suggest workers may not have the necessary skills to match the opportunities available. Re-training and re-tooling workers for service-oriented and technical jobs which tend to suffer longer bouts of unemployment, further delay improvements in the employment rate. Other theories suggest a lack of motivation amongst the unemployed due to the generous unemployment benefits available.
Still other theories suggest an even more challenging issue; the increased uncertainty surrounding global macroeconomic policies. Without clear or stable monetary and fiscal policies in place, businesses will be reluctant to hire, moderate their recruitment efforts or choose not to fill existing vacancies.
As our economies become more global, there is also a trend in shifting manufacturing and fewer technical service jobs to the Far East, prolonging higher unemployment in North America. Admittedly a declining contributor to the US economy, the manufacturing sector remains a dominant player in creating private sector jobs, which drives demand for consumption goods and services.
Given the mandated limits of price stability and full employment, it appears there is very little Bernanke and the committee can do to improve the jobs picture at this point. With an imminent tapering to its asset purchase programme and a zero interest rate policy fully in tow, investors wait with bated breath to see if the largest service economy will defy the odds and propel itself on a sustainable path to real economic growth.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.