Outlook and Market Review - First Quarter 2013

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According to the preliminary announcement by the Bureau of Economic Analysis, the economy grew at a 2.5% annual rate in the first quarter of 2013. Sequestration began in March with only a small impact on first quarter growth, but the Congressional Budget Office estimates that the forthcoming $65 billion reduction in federal spending will lower growth for the year by about 0.5%. Growth in the 1.8% to 2% range is expected in the next few quarters with only slightly better growth going into 2014. The consensus of economists in the Survey of Professional Forecasters as well as those contributing to the Blue Chip Economic Forecast is for growth of no more than 3% for the next few years. In the five years since the Great Recession officially ended, the economy has not had growth as high as 3% in four successive quarters. Unemployment remains high at 7.5% and even with a stronger labor market overall, the unemployment rate is expected to remain above the Fed’s announced target of 6.5% for several more years.

Consumers are keeping the economy above water even though wages and salaries are flat. Consumer spending grew at a 3.2% rate in the first quarter, but savings rates are falling and credit purchases are increasing. A rebound in housing prices and a raging bull market for stocks have bolstered consumer wealth to help support consumer spending, but these forms of support for spending are not permanent. With government spending at all levels in decline and with little permanent support for consumer spending, a serious improvement in growth requires stronger private investment and exports. Business confidence remains low and there is little hope for a significant overhaul of the tax code, entitlement revision, or deregulation in areas that would spur investment. Export-led growth is also unlikely given the overall global economic slowdown.

With growth remaining low, inflation is expected to remain at or below the 2% to 2.5% target of the Fed well into 2015. The labor market is improving and monthly additions to payrolls should continue to be in the 165,000 to 185,000 range throughout the year. Even so, the unemployment rate is expected to remain above 7% for the remainder of 2013 and 2014. Global economic growth is sluggish overall with much of the Eurozone in recession in the first half of 2013.These conditions suggest a prolonged global “easy money” response that the U.S. and Japan have already adopted. Australia and the ECB (Eurozone central bank) have recently joined the bandwagon for monetary easing. With mounting sovereign debt in the last decade, central banks are left with little choice but to keep the cost of debt service low with easy money and low interest rates. Interest rates should remain low with a range of 1.7% to 2.1% for the ten-year Treasury. There is some concern that the raging stock market is pulling funds from bonds and putting downward pressure on bond prices and upward pressure on interest rates. This relationship is not severe at this point, partly due to a lack of investor confidence and sentiment. However, if confidence picks up and risk premiums collapse further, we may see interest rates move up.