We had a little flush of activity in the first quarter, which we believe will lead to much better GDP – potentially well over 3% – than people anticipated in the beginning of the year. We look at this activity as a little bit of a catch-up, for a couple of reasons:
- Inventories are rebuilding. If you recall, there was quite a bit of hesitation in business and other types of spending in the fourth quarter of 2012 due to fears of the fiscal cliff and year-end tax hikes. Inventories ran down, but consumer demand didn’t really wane, so companies fell a little bit behind and have now started filling orders.
- The housing recovery has continued and I think it’s going to end up being a bright spot this year.
- There’s probably been some modest capital spending as well. I think the only drag really will end up being government spending. I’ve seen some reports that suggest private GDP is well over 4% at this point, with the government holding things back a little bit. That’s not a bad place to be.
U.S. GDP Should Slow Somewhat in Q2
I think we’re going to see a bit of a slowdown in the second quarter, although it won’t be like last year, when there were rumors of a possible recession in the second quarter or the middle part of the year. I think we may see GDP of something like 2% or a little less, due in part to:
- Some of that inventory building in the first quarter has helped companies feel more caught up, but we’re not seeing much of an acceleration in consumer spending. Auto sales are holding pretty steady and housing may be getting better, but not very rapidly.
- In addition to the ongoing slow growth in China, we’re seeing a more marked slowdown in Europe.
- The sequester should start to have an impact on the economy, as the furloughs will begin and hours worked in the government will be diminished. That in turn will have an effect on spending ability.
In my view, all of this should keep interest rates where they are – in a tight range. We’ve been treading the low range in U.S. Treasury yields, with the high being a little bit over 2%, on the 10-year. I don’t think U.S. interest rates are going to matter that much to performance this year. Job growth should continue to be pretty slow, so we won’t see the Fed materially change its behavior any time too soon.
Central Banks Turning up the Heat
Speaking of central bank activity, probably the most material shift we’ve seen has been with the Bank of Japan, which announced about $75 billion a month or so of debt monetization, which is really quite substantial given their balance sheet. Their balance sheet is going to double over the coming year or so.
And that move has caused quite a shift in certain asset classes recently. Despite what I think was a well-broadcasted move, the markets were still surprised because the debt monetization was of a more dramatic size and scope than people anticipated. Obviously the yen is much weaker because of that, and the dramatic change in Japan’s liquidity will only, in my mind, exacerbate volatility in the markets as well as make the search for yield on the part of investors even more challenging.
I would also note that the Bank of England has been at the forefront of the monetization, at a steady pace, but they may be changing as well. The only laggard has been the ECB – arguably the one who should be easing the most at this point. But even they are now stepping up, I think, for a little bit easier behavior than they’ve had in the recent month or two.
So I think the situation we’ve been in with the central banks, the U.S. stoking the flames, if you will, has just gotten more intense. The heat’s going to get hotter and I think it’s going to be more of the same, frankly, until no one can bear the yields.