Six years after a recession that rocked the global financial system, there is no shortage of excitement. Especially during a season that is known as the “doldrums of summer,” it has been a week that has propelled equity markets to record levels. On Thursday of this past week, the NASDAQ touched levels not seen for the last twelve years, and the Standard and Poor’s 500 broke and closed above the physiological level of 1,700 for the first time in history. The FOMC released their most recent policy announcement on Wednesday, and continued to distinguish for investors that tapering QE is independent of tightening credit conditions by raising interest rates. The other big news stories were the US Commerce Department’s initial estimates for second quarter GDP, followed by Weekly Jobless Claims report where the number of American’s filing for unemployment benefits drop to the lowest level in 5 and ½ years. And Friday, the marquee event is the always market consuming monthly labour survey or monthly unemployment report.
So as an investor – is it time to be cautious?
Let’s start with the FOMC. They really have no choice but to start tapering their asset purchases, and frankly this point has not been made clear enough. Currently, their monthly purchases of 85 billion break down between mortgage securities and long term treasuries in the amounts of 40 and 45 billion respectively. Annualized, that is 540 billion in treasury purchases. Many economists have estimated that the Fed is currently purchasing anywhere between 60 and 75 percent of the issued treasuries from auction in 2012. Moreover, as the Congressional Budget Office estimates the US Treasury to run smaller deficits in the upcoming years, the market does not require this much support. More to this though is that it exemplifies the role to which the US Fed plays in the treasuries market; Ben Bernanke and his board of governors have to be nervous about the long term consequences of this program, and thus will be looking to draw it down.
According to the Commerce Department though, the US economy looks to be regaining its footing. Quarterly GDP reported on Wednesday of this week came in seven tenth of a percent greater than anticipated. This compensated for the miss in the first quarter of 2013, but the caveat is initial estimates for quarterly GDP have been revised lower on the last four occasions. It the reason the markets shrugged off the reading at first glance as it is still not all that convincing. The other reason for caution, is historically nominal economic growth below 3% has preceded negative real growth and recession. Despite modest upticks in the Fed’s medium and long term outlooks for inflation, currently inflation is practically non-existent; therefore, the economy is more likely to underperform in months ahead.
Good news can be taken from Thursdays jobless claims though as the fewest number of Americans filed for unemployment benefits in over 5 years, and this is a piece of the data that continues to illustrate the merely modest improvements being made in the labour market. And that is why Friday’s July survey becomes all that important. More than the jobless rate, the participation rate will illustrate whether discouraged workers are re-entering the labour force, and as well whether or not the private sector can continue to be the engine of job creation.
This action packed week of what is supposed to be the summer slowdown will set the stage for financial markets going into fall. No question the debate around the Fed’s taper schedule will grow louder and louder, but as an investor the nominal amounts of their bond purchases is of miniscule significance. What is more important is this labour market needs to see gains in participation and quality full time jobs, and this economy requires enough steam to escape a period of disinflation. If not, don’t worry about the doldrums of summer; worry about the doldrums of the United States.