Who says US is about to take off?

DBS economists take a sceptical view of what is ahead for 2014

DBS Bank economists have decided to be heretical in their 2014 outlook.

The recovery of the advanced economies will falter next year rather than gather pace and the US will taper quantitative easing (QE) but U-turn with QE4 later in the year as it does not have the stomach for falling housing prices, the bank said in its "Holiday heresies 2014" yesterday.

This means this year's bull markets in the Group of Three (G-3) - the US, Japan and the eurozone - may demand a partial refund. Asia will have to depend on itself for growth, as it has in the past five years, the bank added.

"All economies had to do in 2013 was avoid disaster for markets to reward them with hefty returns," said DBS Bank chief economist David Carbon.

The US and Japan grew 1.4 per cent and 1.8 per cent, respectively. European Union GDP fell 0.4 per cent. Yet the S&P 500 rose 30 per cent, Japan's Tokyo Stock Exchange's Tokyo Price Index returned 45 per cent, and the Eurostoxx 50 (representing the eurozone's 50 largest companies) returned 15 per cent.

"Generous," said Mr Carbon. "Maybe even bizarre."

While he is not expecting big surprises in real economies, the global "recovery" isn't very strong, he said.

DBS's 2014 forecast is that the US, Japan and eurozone will grow 2 per cent, 1.4 per cent and 0.5 per cent, respectively.

The Monetary Authority of Singapore (MAS) in its October Macroeconomic Review expected a faster pace: the US, Japan and eurozone to grow 2.6 per cent, 1.7 per cent and 0.9 per cent, respectively.

"Grudging growth will continue and markets won't likely kowtow to such pedestrian growth again. They may, in fact, demand a partial refund," Mr Carbon said.

"Many believe the US is on the verge of taking off; we don't," he said.

Consumption - the ultimate driver of everything - has been slowing for three years and is now at a 3.5-year low, whether measured in sequential, quarter-on-quarter (QoQ) terms or in broader on-year terms. Business investment growth has averaged 1.6 per cent QoQ for the past three quarters, thanks to core capital expenditure shipments that have run sideways for 18 months.

The fraction of working- age Americans with jobs is barely any higher today than it was at the nadir of the global crisis five years ago. With weak demand and loads of excess labour supply, inflation by most measures is running at about one per cent - half the US Federal Reserve's target.

GDP growth - surprisingly high at 3.6 per cent in 3Q13 - will fall back in line behind consumption and business investment growth, Mr Carbon said.

"Inventories subtract from, rather than add to, growth; government spending growth remains at zero or less; housing wobbles sideways," he said.

GDP will grow 1.9 per cent in 2014 - better than the 1.4 per cent it probably registered in 2013 - but hardly justifying talk about a "take-off", he said.

"Call it heretical if you like but GDP growth usually does march to the tune of consumption and investment growth - it's the norm, not the exception," Mr Carbon said.

The Fed will taper but lose its nerve later in the year, he forecasts.

"Too many at the Fed really really really want to taper," he said. "Some worry about inflation; some worry about bubbles; some just worry, period."

For whatever reason, the Fed will go ahead and taper anyway - say, around April, he said.

"What makes an April 2014 move strange is that the Fed didn't taper in September 2013 because the data was weak - and because consumption, business investment and housing have weakened further since then," he said.

(By the way, DBS's 2013 crystal ball gazing predicted the Fed wouldn't taper in September this year.)

By April 2014, the Fed's balance sheet will have grown to US$4.4 trillion (5.2 times bigger than in 2008) and officials will decide enough is enough, success or no, Mr Carbon quipped.

But the Fed could U-turn if housing prices fall, with QE4 aimed at the housing market, he said.

The Fed has been buying US$45 billion worth of houses every month since September 2012 - that's five times the value of all new homes being purchased each month.

When the Fed stops buying all those houses, sales will begin to drop, Mr Carbon said.

"Prices (will then) start to fall. GDP growth starts to fall - to 0.5 per cent in 2Q14 and, according to forecasts, below zero in 3Q14.

"(New Fed chief Janet) Yellen's in a pickle. Promises to keep Fed funds at zero forever fall on deaf ears.

"The Fed has no choice: it pulls a U-turn in September. QE returns, with asset purchases aimed entirely at the housing market. Markets dub the U-turn QE4," Mr Carbon added.

The incoming Fed chairwoman last month said that interest rates will remain low following tapering, which the market seems to have absorbed.

But Mr Carbon expects QE4 to be greeted with chaos, rather than cheers.

"Markets do not cheer QE4. On the contrary, they cower. Why? Because the Fed and the economy are now stuck, seemingly permanently, between a rock and a hard place. QE? You can't live with it; you can't live without it. Growth was weak when you had it - and even weaker when you get rid of it," he said.

"It turns out the bond market isn't a sell after all. Ten-year Treasury yields, which jumped to 4 per cent after tapering began in April 2014, fall back to 1.5 per cent by December. The S&P 500 ends the year at 1,200, where it stood at end-2011."

On Europe, Mr Carbon is sceptical, and predicts it could be almost zero growth for another two years.

"When Europe reported positive GDP growth in 2Q13 - the first time in six quarters - many assumed it would continue to accelerate towards 1-1.5 per cent growth. We were, and remain, sceptical," he said.

He also does not expect Abenomics to follow through as structural reforms in Japan will be stalled - as they have been the last 20 years.

The market will finally realise the G-3's ultra-expansionary monetary policies are no panacea.

"The hypothesis here is that in 2014 everyone realises that ultra-expansionary monetary policies were nothing but a great big placebo; they never 'fixed' real economies. So markets that had assumed otherwise become 'unfixed', unglued, uncooperative," he said.

Asia will have to rely on itself to drive its growth as it has done since 2008.

Since the collapse of Lehman Brothers five years ago, the US, Europe and Japan have gone nowhere. Asia has continued to grow at nearly a 7 per cent rate - about average, in other words. In the five years since Lehman collapsed, Asia "added" 1.25 Germanys to the economic map, right here in Asia.

"Even with China's 'slower growth', Asia puts a new Germany on the map every four years. That Asia was capable of driving its own growth used to strike many as heretical; today, it's conventional wisdom," Mr Carbon said.

"We think Asian markets will outperform in 2014, given the expected growth differentials and given how kind/generous markets were to G-3 economies in 2013. We do not expect them to be so kind to the G-3 in 2014," concluded the DBS Bank chief economist.

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