Economic Outlook 2014:
The Economy is Starting to Look Up,
But TheFed Must Balance Two Bad Choices.
Presented by:
S. Scott MacDonald, Ph.D.
Tuesday, January 14, 2014
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Economic Outlook 2014:
The Economy is Starting to Look Up, but the
Fed Must Balance Two Bad Choices.
S. Scott MacDonald, Ph.D.
President and CEO, SW Graduate School of Banking Foundation
Director, Assemblies for Bank Directors
Adjunct Professor, Dept. of Finance, Cox School of Business
Southern Methodist University
scott@swgsb.org
www.swgsb.org
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The Southwestern Graduate School of Banking
Assemblies for Bank Directors
Southern Methodist University „ Cox School of Business
PO Box 750214 „ Dallas TX 75275
Phone 214-768-2991 „ Fax 214-768-2992
info@swgsb.org „ www.swgsb.org
S. Scott MacDonald, Ph.D.
smacdona@mail.cox.smu.edu
S. Scott MacDonald is president and CEO, SW Graduate School of Banking (SWGSB)
Foundation, director of the Assemblies for Bank Directors, and Adjunct Professor of
Finance, Cox School of Business, Southern Methodist University. He received his B.A.
degree in economics from the University of Alabama and his Ph.D. from Texas A&M
University. Dr. MacDonald joined the Southern Methodist University faculty as a visiting
professor of Finance in 1997 and was named director of the SWGSB Foundation in 1998.
Dr. MacDonald is a frequent speaker at professional programs, banker associations and
banking schools. He is a nationally sought after strategic planning facilitator and
consultant to the financial services industry. He has served as an expert resource
witness before the Texas state Senate and is a former Chairman of the Board of
Directors of a Texas financial institution. Dr. MacDonald is the co-author of the best
selling textbook on banking, Bank Management, and the author of numerous articles in
professional academic journals.
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Economic Outlook
Getting Better!
More are on the 2014 bandwagon.
But Fed Policy Could Derail!
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GDP revised upward to 4.1 percent
That would be “recovery” range
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North Dakota is the strongest economy,
but the Texas economy continues to be
the star of the show…
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The consumer outlook is more
positive
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Cars continue to sell…
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Housing starts pasted the million
dollar mark!
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Unemployment gradually improves
to 7.0 percent.
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Still a ways, however, from “getting
back to normal” in labor markets…
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But adding to the payrolls every
month, just not fast enough…
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The big three:
Wealth (stocks, best year)
Housing ($1 million starts)
Unemployment (passing through 7%)
Is 2014 the year of the recovery?
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U.S. construction spending rose to its
highest level in nearly five years in
November as a surge in private
construction projects offset a drop in
public outlays
Private residential spending hit its highest level since June
2008 and outlays on nonresidential structures, which include
factories and gas pipelines, touched an 11-month high.
Public construction spending fell 1.8 percent as both outlays
on federal and state and local government projects declined.
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Residential housing continues to be
the star of the construction show…
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Highway and street construction,
however, is somewhat stagnant…
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Commercial has seen an uptick
recently…
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Construction payrolls improving…
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Economic Uncertainty
Continues…
“As long as you don’t know the rules and
yields remain near zero, the economy will
continue to struggle.”
--S. Scott MacDonald, Ph.D.
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The budget deal
Basically, postpones for two years the across
the board sequestration cuts.
So, the best news of the day is resolution to
some uncertainty.
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All of this for so little…
• Spending
• Increases discretionary spending in fiscal 2014 by
$45 billion over the mandated sequestration level:
evenly divided between defense and non-defense.
• An additional $18 sequestration relief in fiscal
2015
• Revenues
• Higher pension contributions from federal workers
• Cost of living reductions for veterans’ pensions
• Increased air passenger user fees and other
policy changes
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But it does not touch…
• Social Security, Medicare benefits or other
"mandatory" spending
• The deal does, however, extend the
sequester's 2 percent cuts to Medicare
providers by two years. Instead of lapsing in
2021, those cuts will now lapse in 2023.
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In reality, it appears to be a
bunch to do about nothing!
The deal's an agreement on top line
discretionary budget level .
Now members of the House and Senate
Appropriations Committees must negotiate on
individual spending accounts, with the current
continuing funding resolution expiration date of
January 15th approaching.
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But the other story is the
expiration of tax breaks
Lawmakers let many tax breaks
lapse almost every year.
…and almost every year, Congress eventually
renews them, retroactively, so taxpayers can
claim them by the time they file their returns.
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Congress adds additional uncertainty by
allowing the tax breaks to expire then most
likely renew the next year…
• Credits for companies that invest in research and
development, generous exemptions for financial
institutions doing business overseas, and several breaks
that let businesses write off capital investments faster.
• Benefits targeted to film producers, race track owners,
makers of electric motorcycles and teachers who buy
classroom supplies with their own money.
• Deduction for state and local sales taxes benefits people
who live in the nine states without state income taxes
(Alaska, Florida, Nevada, South Dakota, Texas,
Washington, Wyoming)
• Series of tax breaks promotes renewable energy,
including a credit for power companies that produce
electricity with windmills.
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The Fed must now balance,
chaos on the one hand and
total disaster on the other!
Taper to fast and bond traders will
run for the hills.
QE too long and massive inflation will occur.
A stronger economy that the Fed expects,
could be “bad” for long-term interest rates!
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We talked our way into
QE3+
“If you can’t lower interest rates anymore
because they are at zero, what’s the next best
thing? Promise never to raise them.”
--S. Scott MacDonald, Ph.D.
Now the Fed must talk the markets down
from a $4 trillion “high.”
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QE has had a positive impact upon 401k’s,
but not long-term interest rates—as intended.
Now we have the “hangover” to deal with!
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Will the hangover result in $120
gallon of milk?
The money supply is up from $800 billion to $4 trillion, a little more
than 4 times and the money multiplier is 10 times.
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The exit strategy debate
• The exit strategy approved two years ago called for the
Fed to sell its portfolio of mortgage-backed securities
over three to five years,
• Since the Fed buy’s about 85 percent of net issues of
long-term government and mortgage back securities, this
could have a dramatic impact on long-term bonds.
• Minutes of the Fed’s policy-setting meeting in June
(2013) show that most officials now believe the central
bank should hold on to that debt.
• Reason: its to big to deal with?!?!?!?!?
• Problem: they assume 30 year mortgages will pre-pay in
3-6 years, wrong. Extension will be much higher.
• Problem: potential capital losses if the Fed holds the
bonds.
• Problem: potential significant inflation as banks begin to31
lend again.
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By the end of 2013, everybody
was getting on the ‘QE is not our
friend’ bandwagon!
"Now if money suddenly got velocity, if people began to
lend and spend, the Fed would be very, very hard put.
… If money got velocity, I would think you would see
things begin to turn topsy-turvy. They would taper at
the speed of sound."
--Art Cashin, UBS
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The stock market loved it,
bonds, not so much!
But what happens next?
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Longer term rates are on the rise…
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“The odds are against a successful withdraw
by the Fed. The Fed can change how things
look. It can't change what way things are."
James Grant, Grant Interest Rate Observer.
"You say, 'There's no inflation?' How about
Wall Street? Stocks and bonds and art and
Ferraris and farmland, assets are up,"
--James Grant
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Bill Gross and Mohamed El-Erain both
indicate the Fed will keep rates low for a
long time (2016)
• The big caveat that keeps getting overlooked
was clearly stated by El-Erain.
• …they can only control part of the yield curve.
We should have not doubt they will try to keep
rates low. How are they going to do this? By
keeping policy rates (Fed Funds) near zero.
So they can anchor the front end of the yield
curve, but it is doubtful they can anchor the
long end of the curve. Don’t mistake how
much control they have over the long end of
the yield curve.
--El-Erain, Tuesday, Dec. 3, 2013
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Is a 'panic taper' the real risk to
markets?
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•
•
•
•
"The real issue is not when they will start to taper, it's whether the
taper be voluntary by the Fed and controlled on their timetable, or
whether it be accelerated and forced upon the Fed as the year
moves along and the economic data becomes too strong or inflation
raises its head."
"If velocity rises, the Fed won't be able to drain quantitative easing
reserves fast enough to calm anxieties of potential
overheated/inflationary consequences from the past few years QE
program."
"Typically, Fed policy shifts gears only under panic conditions and
this is my best guess as to how Fed policy will most likely be
reversed in 2014."
"It's not critical that we have a real inflation problem. It's just a matter
of whether we have an inflation fear and I can see the ingredients of
that. That to me is the bigger event that could occur sometime in
2014,“
--Jim Paulsen, Chief Investment Strategist at Wells Capital Management
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The 2014 Economy
5 Questions on the Economy to
Be Answered in 2014
--Sudeep Reddy, WSJ
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Will businesses finally start playing the
game or will they stay on the sidelines?
• The financial crisis led business owners and
corporate executives to be especially wary about
adding staff or investing in new equipment.
• Risks from Washington or overseas.
• If consumers maintain slow-but-steady spending, this
will provide little incentive to deploy their cash
stockpiles.
• But a slowly improving jobs picture and rising
household wealth could spark stronger consumer
spending, increased business confidence and
investment.
• If not, 2014 could be another letdown.
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Will Washington get its act together?
• The December budget deal was
less than exciting
• But it hit the pause button on
the serial brinkmanship that
threatened to derail the
recovery in the past three years.
• A combination of tax increases and spending cuts in
2013 shaved about 1.5 percentage points off annual
economic growth
• Many forecasters expect the fiscal drag in 2014 to be onethird that amount, or less. “You’ll have more political certainty
this year,” said Gregory Daco, a U.S. economist at Oxford
Economics.
• But, some lawmakers already are discussing a
standoff again in late February over raising the federal
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borrowing limit.
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Will the Fed be forced into a panic taper?
• The Fed laid out a timetable to slow the pace of
purchases by $10 billion at each meeting until it is no
longer buying bonds at year-end.
• Few of the Fed’s forecasts have proceeded
according to plan during the course of the economic
downturn and choppy recovery, a fact that Fed
officials now openly acknowledge.
• “We have been disappointed in the pace of growth, and we
don’t fully understand why,” --Bernanke
• The Fed spent more than six months last year
signaling its intent to taper and the prospect upset
markets at just about every turn.
• Even if the tapering is smooth, the Fed could spend
much of the year grappling with the prospect of
raising its interest-rate target as early as 2015.
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Will the bright spot, housing take
rising interest rates in stride?
• The housing sector started last year on a high note.
• It ended the year facing worries about higher interest
rates, supply constraints, tight credit and a host of
other problems.
• Sales of previously owned
homes have slipped every
month since July.
• That coincides with the surge
in borrowing costs as the Fed’s
signals about its bond buying program.
• Expect the average 30-year fixed-rate mortgage to hit
5.5% or more at year-end, up from 4.5% late last
year and 3.5% in the first half of 2013.
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We are not alone!
• Once the U.S. economic recovery started in 2009,
other parts of the world began to struggle in their own
ways.
• Europe fell into a debt crisis.
• Japan faced a natural disaster.
• Emerging markets, once the bright spots on the
global landscape, lost their glow.
• Political crises from Italy to Egypt to Thailand
raised the prospect of more global unrest.
• The world got by in 2013 with fewer confidenceshaking moments than in prior years
• The relatively stable global outlook must continue if
2014 is to be the kind of economic year Americans
have been hoping for throughout the recovery.
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David Rosenberg, Gliskin Sheffs
summarizes the 2014 outlook.
1.
2.
3.
4.
There is more upside potential in 2014 than downside risks.
The stock market suggests that economic growth will improve
in 2014.
Fiscal headwinds will subside and business spending could
emerge as the key catalyst for growth next year.
The U.S. economy does not suffer from secular stagnation.
1. The economy had so far been held back by household and federal
government balance sheet repair.
The capital stock is very old and will be replaced.
6. With the housing recovery's role in supporting the economy,
the torch will have to be handed over to the consumer.
7. Job market and consumer confidence improve.
8. Future returns in the stock and bond markets will be muted.
9. The Fed will fall behind the curve.
10. Expect volatility as Janet Yellen prepares to take over from
Ben Bernanke.
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5.
http://www.businessinsider.com/david-rosenberg-2014-outlook-for-us-economy-2013-12
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