Tighter Fed Policy Will Boost Economy: Cutting Research

The increasing likelihood of a Federal Reserve interest rate increase next year should help rather than slow the U.S. economy, according to UBS AG.

Capital spending as well as mergers and acquisitions should rise with the anticipation of tighter policy after a period of near-zero interest rates and low volatility cut the impetus for companies to invest, Stamford, Connecticut-based economist Drew Matus said in a March 31 report.

“The expectation for rising rates may prove helpful,” said Matus. “Low rates not only lower the cost of delaying investment decisions but also encourage other behavior that can be detrimental to business investment.”

In periods of low rates, equity investors usually favor companies that buy back shares and pay dividends, said Matus. That encourages chief executive officers to use cash in those ways, rather than invest in new plants or machinery.

“The result is obvious -- lower capital equipment spending (and mergers and acquisitions) than otherwise would occur,” said Matus.

The expectation for the Fed to raise its benchmark next year may reduce the returns of buybacks and dividends while making capital investment more attractive this year, said Matus, a former Federal Reserve Bank of New York economist.

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Improving prospects for the U.S. may still throw a lifeline to struggling emerging markets amid suggestions the world’s largest economy is no longer consumer of last resort.

While U.S. import growth appears less sensitive to domestic demand following the financial crisis, that decline may mask how exporters to the U.S. have had to compete on price to maintain market share, Deutsche Bank AG economists led by New York-based Peter Hooper said in a March 28 report.

After adjusting for inflation, the level of imports as a share of domestic demand has been relatively stable, the report said. This shows shipments from emerging markets have risen proportionally with U.S. economic strength.

“This proportional relationship represents some decline in the impetus to EM exports from a pickup in U.S. growth relative to earlier historical experience, but it is still a substantially positive impetus, far from a decoupling,” Deutsche said.

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Investment flows between Europe and China could match the 500 percent increase in trade of the last decade.

Investment should accelerate as the European economy stabilizes and becomes more flexible in the wake of its debt crisis, said HSBC Holdings Plc economists and strategists in a March 24 report. Negotiations on an investment treaty began this year, showing the direction of policy.

Chinese overseas direct investment already has tripled over the past five years and should continue to grow, HSBC said. Even so, it still only accounted for 6 percent of global flows as of 2012, less than the country’s 10 percent share of the world economy. Savings equivalent to half of China’s gross domestic product indicate there’s money available.

Europe will benefit because China is set to invest more in goods and service industries, after first focusing on primary industries. In 2012, Europe was the destination for 14 percent of Chinese investment in goods and services, compared to just 1 percent in primary industries and 5 percent in infrastructure.

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The European Central Bank didn’t unsettle inflation expectations or erode its credibility by expanding its balance sheet.

Crisis-era asset purchases and long-term loans to banks led only to a “slight increase” in investors’ anticipated inflation in periods up to ten years, Richhild Moessner of the Dutch central bank wrote in a recent report.

There is “no strong evidence to suggest that ECB balance sheet announcements have led to much higher long-term inflation expectations, suggesting that the monetary policy credibility of the ECB has not been harmed by these policies,” Moessner said.

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The euro is uniting prices across the single currency bloc as its founders hoped.

Looking into the “law of one price”, which states that identical goods should sell for identical prices or else markets will adjust for the difference through arbitrage, a new paper finds prices have converged within the euro area.

The gap in prices is 30 to 50 percent lower in euro zone countries than in neighboring countries with exchange rates that are pegged to the euro, said Roberto Rigobon and Alberto Cavallo of the Massachusetts Institute of Technology and Brent Neiman of the University of Chicago.

The study, to be published by the Quarterly Journal of Economics, studied the prices of almost 120,000 products including those of Apple Inc., Ikea, and Industria de Diseno Textil SA, also known as Zara, from October 2008 to May 2013.

While such a development was envisaged by the euro’s creators, unified pricing may hurt recession-hit countries such as Greece because it reduces the purchasing power of consumers.

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Recessions don’t necessarily force U.S. workers to switch careers, confounding the theory that slowdowns reallocate resources to new and better uses.

The fraction of the unemployed who change their industry or occupation declines during slumps rather than increases, according to a study published this week by the Federal Reserve Bank of San Francisco.

“This reflects in part that, when unemployment is high, employers can find applicants with qualifications that closely match job openings,” said Carlos Carrillo-Tudela, Bart Hobijn and Ludo Visschers. “Thus, the rate of overall job growth affects the pace of job market recoveries more than the need for workers to reallocate across sectors.”

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Goldman Sachs Group Inc. economist Aleksandar Timcenko turned to basketball in an attempt to discover if people become more assertive and self-confident in good economic times.

Taking data from the National Basketball Association since the mid-1950s, Timcenko looked at the ratio of the annual average of fouls per game to that of assists.

He found that the “NBA selfishness ratio” is closely correlated with economic activity, suggesting as the economy improves, people are more likely to take control and be less trusting. While the report was published on April 1, Timcenko said the “pinch of humor” analysis was accurate.

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editors responsible for this story: John Fraher at jfraher@bloomberg.net Paul Badertscher, Chris Fournier

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