Fed Policy Aids U.S. Financial Strength BofA Deems UnrivaledCordell Eddings
Five years after Federal Reserve Chairman Ben S. Bernanke dropped U.S. interest rates toward zero to end the worst economic crisis since the Great Depression, America’s financial markets have become the envy of the world.
From money-market rates to yields on government and company bonds to equity prices, financial conditions in the U.S. are healthier than before Lehman Brothers Holdings Inc. collapsed in 2008, even as growth falters in Asia and Europe. The U.S. now has the strongest economy among industrialized nations, which would be its highest rank since 2000, according to David Woo, the New York-based global head of interest rate and currency strategy at Bank of America Corp.
“Resilient is the word that comes to mind in regards to the U.S.,” Paul Montaquila, the fixed-income investment officer at BNP Paribas SA’s Bank of the West, which oversees $62 billion in assets, said in a telephone interview from San Ramon, California. The strength of the financial markets demonstrates “the U.S. is still the preferred market of choice for global investors and the most-important engine of growth.”
While the Fed’s decision to push borrowing costs to historical lows in December 2008 helped developing economies recover more quickly as the U.S. housing bust crippled Americans’ ability to spend, investors are now showing greater conviction that the nation will underpin growth globally.
The optimism comes even after the impasse between lawmakers last month pushed the U.S. to the brink of its first default and left Americans’ approval of their congressional leaders at a 39-year low.
Buoyed by the Fed’s purchases of assets in the debt markets, the U.S. has financed spending with record demand for Treasuries in the past four years and companies are on pace to obtain more bonds and loans than ever this year. That’s bolstered the world’s largest economy and pared its deficit to the smallest in five years.
Under Bernanke, the Fed cut its target overnight lending rate by 5 percentage points in a span of 16 months to between 0.25 percent and zero as the credit crisis debilitated the nation’s banks, businesses and consumers and tipped the U.S. into its deepest recession in seven decades.
The central bank also implemented its quantitative easing program, designed to restore demand by suppressing longer-term borrowing costs with purchases of Treasuries and mortgage-backed securities. Since QE started in 2008, the Fed has bought more than $3.5 trillion of debt to help kickstart the economy and has currently pledged to purchase $85 billion of bonds each month.
The Fed’s largess helped repair confidence in the U.S. financial system and restored the conditions that enabled the economy to begin recovering, according to Jennifer Vail, head of fixed-income research of the Minneapolis based U.S. Bank Wealth Management, which oversees $110 billion.
“Five years ago we were on the brink of collapse, the markets were frozen and you couldn’t trade a thing,” she said in a telephone interview on Nov. 13. “And QE changed that. It was a success at keeping everything from falling apart.”
Based on Bank of America’s model, which analyzes jobs, the balance of goods and services and net borrowing, the U.S. is now rated higher than nine other economies from the euro-area to Japan and Canada, beating out Switzerland for the top spot. At the start of the financial crisis in 2008, the U.S. would have been the lowest-ranked economy.
In the past year, both joblessness and the deficit in the U.S. fell the fastest of any economy, while its current account improved more than at any time in the past five years, according to Woo’s report on Nov. 14 introducing the model.
The last time that the U.S. showed such a broad-based and sustained gains was in the last 1980s, he said.
“The U.S. has been the most-improved economy in the world in 2013,” Bank of America’s Woo said in a telephone interview. “The economy has transformed from being the most-imbalanced economy in the last decade to the most-balanced economy and a stronger financial outlook in this decade.”
While the 16-day government shutdown last month weakened growth this quarter, the $15.7 trillion economy will expand 2.6 percent next year, according to economists’ surveys by Bloomberg. By 2015, the economy is projected to grow 3 percent, which would be the most in a decade.
Among the most-creditworthy nations, bond investors are signaling more confidence in the growth prospects for the U.S. Ten-year Treasuries now yield 1.36 percentage points more than five-year debt, the most since 2011 and about twice the average in the five years before the financial crisis.
The gap, which increases as the outlook for the economy strengthens and narrows when it wanes, is also wider than the average for the 12 nations rated AAA by Standard & Poor’s than at any time since April 2012.
The benchmark 10-year yield fell 4 basis points, or 0.04 percentage point, last week to 2.71 percent in New York, Bloomberg Bond Trader prices show.
Yields are still well below their average of 4.6 percent over the last two decades even as the amount of outstanding U.S. debt more than doubled to a record $11.7 trillion. Treasury 10-year notes yielded 2.68 percent as of 12:26 p.m. New York time.
As momentum builds in the U.S., the world’s developing economies are weakening. Last month, the International Monetary Fund reduced its 2013 growth forecast for emerging markets to 4.5 percent, which would be the slowest since 2009. In July, the Washington-based fund predicted 5 percent growth.
China’s economy will increase by 7.6 percent this year, the least since 1999, IMF data show. India, which last year had its worst current account deficit as a percentage of its economy since at least 1996, will grow less than 4 percent for a second straight year, which hasn’t happened in at least three decades, the data show.
Deepening concern over a slowdown in the region’s export-led growth has caused Asia’s financial health to deteriorate, leaving investors in the region’s currencies with the biggest losses on record versus the dollar over the past two quarters, data compiled by Bloomberg show.
In Europe, the region’s economies are still struggling to recover from its longest recession after nations from France to Ireland and Greece slashed government spending to combat their own debt crises.
The 17 nations that share the common currency will contract 0.3 percent this year before expanding 1 percent in 2014, according to economists’ estimates compiled by Bloomberg. An index of consumer prices fell to the lowest in almost four years in October, prompting the European Central Bank to cut its rate to a record-low 0.25 percent this month.
“The developed world out of the U.S. is still struggling and emerging markets have worsened over the past year,” said Bank of America’s Woo. “The U.S. has finally made the adjustments it needs to compete with the China’s of the world, and it’s starting to show.”
Jack McIntyre, a money manager who oversees $44.5 billion at Brandywine Global Investment Management LLC, says a lack of inflation in the U.S. is restraining demand even as the Fed’s stimulus boosts asset prices, a sign the central bank’s ability to spur growth with more cheap money is waning.
The personal consumption expenditures index, the Fed’s preferred gauge of inflation, increased 0.9 percent in September from a year earlier, the 17th straight month that consumer prices have remained below the Fed’s 2 percent target.
“There is no doubt that the influence of QE has diminished, and it’s get less bang for its buck at a time where risk to growth still remain,” McIntyre said in a telephone interview. “The economy has grown, but it’s just not clear yet where liftoff will come from at a time when the Fed just can’t do much more without great risk.”
The rallies in financial assets has alarmed Laurence D. Fink, chief executive officer of BlackRock Inc., the world’s largest money manager with $4.1 trillion in assets, who said on Oct. 29 that the Fed is contributing to “bubble-like markets.”
Junk bonds are poised for a fifth year of gains as yields fall within a half-percentage point from an unprecedented low, Bank of America Merrill Lynch indexes show. The Standard & Poor’s 500 Index has jumped 26 percent this year to an all-time high and is on the verge of its biggest advance since 2003.
Gains in riskier assets are a reflection of optimism in the economy’s prospects that the Fed has helped to revive rather than a sign of any overexuberance, according to U.S. Bank Wealth’s Vail.
Companies in the U.S. have enjoyed lower borrowing costs as bond yields fell to an average of 4.5 percent in the past four years. That compares with 6.14 percent in the five years before Lehman’s bankruptcy and represents a savings of $16.4 million annually per every $1 billion borrowed.
Businesses took advantage to lock in record-low rates, push out maturities and raise cash by selling $6.3 trillion of bonds since 2008, data compiled by Bloomberg show. Companies have raised about $3.45 trillion in the bond market this year, poised to exceed 2009’s record $3.93 trillion, the data show.
Access to cheaper capital helped lift corporate profits to a record $2.1 trillion for the quarter ended June 30, more than twice the amount in the last three months of 2008, according to data since 1947 from the U.S. Bureau of Economic Analysis.
Greater demand for U.S. goods and services may help to bolster jobs growth, which along with price stability are the Fed’s two mandates.
The unemployment rate fell to 7.3 percent in October from a peak of 10 percent in 2009, as employers added 204,000 workers last month, exceeding all 91 forecasts in a Bloomberg survey, Labor Department figures showed on Nov. 8. The median projection was for a 120,000 gain.
“U.S. growth has been tough but steady,” Robert Tipp, the chief investment strategist at Prudential Financial’s fixed-income division, which oversees $395 billion in bonds, said in a telephone interview on Nov. 13. “Now the U.S. is one of the few bright lights out there globally.”
Lower borrowing costs have also enabled the Obama administration to finance deficits as it increased government spending to mitigate the fallout from the recession.
Investors bid 2.87 times the $1.855 trillion of notes and bonds sold at Treasury auctions this year after a record 3.11 times last year. That compares with 2.26 times when the U.S. ran budget surpluses from 1998 to 2001.
With the economy poised to accelerate, higher tax revenue combined with the mandatory spending cuts that were triggered in March are shrinking the annual shortfalls.
The deficit, which will equal 4 percent of the nation’s gross domestic product this year, will narrow to about $560 billion, or 3.4 percent in 2014 and decrease to 2.1 percent in 2015, according to the Congressional Budget Office.
That would be the least since 2007. As recently as 2009, the deficit ballooned to as much as 10.1 percent of GDP.
Janet Yellen, nominated as Bernanke’s successor at the Fed, told Congress on Nov. 14 she will carry on with the central bank’s stimulus until she sees more improvement in an economy that she says is still operating well below its potential.
“Supporting the recovery today is the surest path to returning to a more normal approach to monetary policy,” Yellen, currently the Fed’s vice chairman, said in the prepared remarks to the Senate Banking Committee.
Traders project an 86.9 percent chance the Fed will keep its benchmark rate at current levels by December 2014, compared with a 72.7 percent likelihood a month earlier, Fed funds futures data compiled by Bloomberg show.
Economists in a Bloomberg survey on Nov. 8 anticipate the Fed will start paring its bond purchases to $70 billion a month at their March 18-19 meeting.
“Growth continues to be steady,” Zach Pandl, a senior interest-rate strategist in Minneapolis at Columbia Management Investment Advisers, which oversees $340 billion, said in a telephone interview on Nov. 12. “The Fed boosted market confidence at critical moments during the recovery.”
To continue reading this article you must be a Bloomberg Professional Service Subscriber.
If you believe that you may have received this message in error please let us know.