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How great is the market-economy disconnect?

Tuesday, March 14, 2017 - 11:17

Wall Street is being supported by expectations that the US economy is strong and will gain even more strength once the Trump administration unveils its fiscal and spending programmes. So far, there has been no inkling of what these policies might be, other than they will be "phenomenal'' and that lots of jobs will be created. Despite this absence of clarity the US Federal Reserve, like the rest of the market, appears to have bought into the idea that massive fiscal spending in a robust economy with full employment will result in inflationary pressure, and so it has strongly signalled that interest rates will have to be raised very soon, and possibly quickly afterward. This in turn has prompted many observers to remark that the Fed is "behind the curve'' and will scramble to play catch-up.

I'm not so sure the Fed is that slow on the uptake, or that it has misread the data. Take a look at the Atlanta Federal Reserve's advance estimate of 1Q US  GDP growth - 

https://www.frbatlanta.org/cqer/research/gdpnow.aspx?panel=1

The figure is a meagre 1.2% which in my book is not great by any means. This is the latest figure (as of 8 March) and unless there is an explosive surge in the next two weeks to significantly revise that figure upwards, the actual number will be somewhere close.

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Of course, markets may then brush of the weak number as suggesting the Fed won't have to rush to raise rates, in which case stocks are still a buy. We could well see a revival of the "Goldilocks'' argument to justify higher and higher prices, namely that 1.2% growth is "not too hot, not too cold'' which is then an ideal situation to keep the game going.

But if you're concerned with fundamentals, this flash estimate must be of some concern. Also, it's worth mentioning that the OECD in its Global Interim Economic Outlook said "there is a disconnect between financial markets and the real economy.."consumption and investment are weak, there are mounting political and policy uncertainties and trust in government is low''. It also touched on high house prices relative to rents. 

BT's Tokyo correspondent Anthony Rowley has written about the OECD report in today's paper- see page 25 "Global economic disconnect likely to lead to crash landing''. It might be an exaggeration to say there could be a crash landing, but certainly the disconnect is worrying.

 

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