Ever since the first QE program finished, there has been hope that the US economy could fly on its own without need for help from the Fed. The first withdrawal from QE caused the economy to sag and quickly brought about QE 2. The second withdrawal attempt was not quite as dramatic, but still forced the Federal Reserve to institute “Operation Twist” which was another easing program albeit in a slightly different form. When this program proved ineffective at helping the economy reach a self sustaining speed, the Federal Reserve went “all in” with QE 3. This Quantitative Easing program differed from the others in that it had no end date. The Fed committed to continually expand their balance sheet until they met their economic objectives. This “QE infinity” seemed to do the trick, and helped the American economy out of its funk.
But there has been considerable worry that the withdrawal of this QE program would once again cause the American economy to sag. At first it was the taper. The mere slowing down of the rate at which the Federal Reserve was buying bonds caused all the economic doomsdayers to forecast a collapse in the economy. When that didn’t pan out, it was the actual end of the Quantitative Easing program that would be the next trigger. I remember being inundated with chart after chart of comparisons of the end of the previous QE programs with the end of QE 3. It was supposed to only be a matter of time before the lack of Fed buying caused the US economy to roll over.
I am not claiming that I haven’t been sympathetic to this view. Every other end of Quantitative Easing has caused the economy to slump. Wouldn’t you be ignoring the facts if you stubbornly refused to acknowledge this past reality?
Yet at the same time, there has to be a point where you have to admit that maybe the economy is ready to fly on its own.
I am not sure if I am yet ready to jump out of the nest, but I have been surprised at the resilience of the American economy over the past few months. There has been an awful lot of bad news thrown at it, but it refuses to roll over. Between the collapsing global economy and the soaring US dollar, I was skeptical that the American economy would be able to continue to chug along. When you throw in the end of Quantitative Easing and the relatively hawkish Federal Reserve rhetoric, there were lots of reasons to expect the US economy to sag.
And to be fair, at the margin the US economy has suffered from all these headwinds. There has been signs like the poor trade deficit report or the slumping durable goods orders that show that the US is not immune. There is a chance that these negative forces will just be slow in showing up. Maybe the US economy is on the verge of slipping into the same deflationary funk that the rest of the world is mired in.
I have argued that I think the global economy is on the verge of bottoming, but so far my prediction has been laughably bad.
I guess it has stopped getting worse, but global GDP seems to be stuck in the mud.
However let’s not forget that monetary policy works with a lag. For the past few months Central Banks have been aggressively cutting rates and expanding easing programs. These moves are not going to instantly translate into economic growth. It takes a while. And some of the bigger moves, like the ECB’s program have not even started yet (it is scheduled to commence in March). It also shouldn’t be long before China also panics and pushes down on the economic accelerator. So I am not giving up on my forecast that global economic growth is about to turn upwards.
But what does that mean for the US? I was leaning towards the idea that the US would succumb to the global slowdown. With the end of quantitative easing, the strong dollar, the collapse in oil prices (which was previously the best performing sector of the US economy), the Federal Reserve threatening to raise rates, I just figured it would eventually be too much negatives for the US economy to handle.
What if I am wrong? What if the US can scrape by with all these negatives, and then in a couple of months the global economy turns?
I created this interesting chart of the Bloomberg ECO Surprise Index. This index measures the “degree to which economic analysts under or over estimate the trends in the business cycle.” It measures the difference in the actual economy versus consensus.
In the chart, I have highlighted every March 1st with a vertical line. What is interesting is that this date often proves to be an inflection point for a change in the perception about the economy.
If this trend continues, we could see another few weeks of economic numbers being worse than consensus, with a bottom at the end of the month.
This turn would also coincide with the start of the ECB’s QE program.
I think there is a good chance that come March, the global economy will pick up enough that it sends the US economy back upwards.
Now don’t get me wrong – I am not advocating buying stocks because the US economy might turn up. I still think that stocks are a disaster waiting to happen. But it might be a good point to think about shorting the bond market.
Either way, this tendency for March to mark the turn in the perception about the economy is definitely something to think about…