US 'Goldilocks' Recovery Paves Way for Three Months More Fun

US 'Goldilocks' Recovery Paves Way for Three Months More Fun

'Not too hot, not too cold' just about perfectly sums up the state of the US economy right now. With first quarter growth of about 2.5% on an annualised basis, and surprising resilience so far to tax rises and spending cuts, this is a sweet spot for risk assets, and equity markets especially look set to enjoy a vintage summer.

Last Friday's relatively strong US employment report gave a glimpse of an economy which is making great headway against the two major headwinds with which it was confronted at the start of the year; fiscal adjustment and the Eurozone debt crisis.

The labour force increased by 210,000, employment by 293,000, and at least the participation rate, at 63.3%, (this measures how many workers are actually trying to get jobs, rather than being discouraged from doing so), stopped falling, after a virtually continuous decline since May of last year. Jobless claims for the week ending May 4th continued the good news, coming out at 323,000, the lowest reading since 18th Jan. 2008.

The conclusion I would draw from the employment report is that private enterprises, (and perhaps even government departments), anticipated the imposition of the Sequester's spending cuts and pared back on hiring a few months ago, so that now the Sequester is actually beginning to take hold, the jobs market is standing up pretty well.

Ironically, given its prominent role in bringing the global economy to the brink of disaster in 2008, the US housing market is increasingly robust-leading to tangible collateral health in related industries and in household retailing.

In a further testament to the growing strength of the recovery, the daily Rasmussen Consumer Index, which measures consumer confidence on a daily basis, rose to 106.2 on May 5th, the highest level since 2007. Given that consumption accounts for approx. 70% of the US economy, this makes very interesting reading. No surprise; house prices are up, and so are stocks.

When it comes to the Sequester, it seems that 'sell the rumour, buy the fact' applies. Maybe there is also quite a strong psychological factor at work here, in that hard-working 'middle America' may well feel very good about the fact that the deficit is being tackled-in the same way we all feel a sense of elation when the mortgage or car loan is finally paid off, say.

However, these measures of economic health don't come near the thresholds which might make the Fed think about curtailing its QE programme. The ruling class of uber-doves at the Fed will hold sway for sure, for the near future at least, and that will keeps stocks rising.

So what about the Eurozone, or Greater Germany, as one might dub it? This particular herd of cats seems, for the moment, safely corralled. Will it last, or will the blistering heat of summer bring out protesters in their millions throughout the South? Here also there are some signs of encouragement, in the shape of the still, small voice of compassion from Brussels, now acquiescing to relaxations in the terms of Peripheral austerity packages-more time here, smaller cuts there. This will characterise the summer months, along with the probable introduction of a targeted credit easing scheme as a joint effort between the ECB and the European Investment Bank, etc. Something similar to the UK's Funding for Lending scheme.

Then, in September, Angela Merkel will in all probability win her election, being able to form a coalition. (But watch how the "Alternative for Germany" (AfD) party is doing in the polls-it's just possible they spoil the coalition arithmetic). Assuming Merkel wins, she will then have the mandate, (well, the power anyway), to put the crisis to bed once and for all by agreeing to a fiscal union and perhaps even Eurobonds. But that is a story for Q4 onwards.

So the Fed keeps printing and the BOJ has only just started, but with a programme three times the US, in GDP- adjusted terms.

Where will this all end? How about 1800 for the S&P by September? That's when you sell this year, because by then Goldilocks' porridge will be getting just a little too hot to eat. 10-year US Treasuries yield 1.8% today and will be through 2.0% by then, ready for a pretty rapid run up to 2.5% by Christmas and suddenly elephants with long memories, like myself, will begin to chatter about 1994, when the Fed caused bond market carnage with unexpected Fed Funds Rate hikes. This time will be different-the Fed's communication policy has improved immeasurably since then, (think Laurence Olivier vs Silvester Stallone), and Bernanke will begin to signal concerns well before any actual tightening, but that will be enough to rapidly steepen the US interest rate curve and deflate the equity market's liquidity-fuelled rally.

'Don't fight the Fed' has never been better advice, but now one should add the BOJ, the BOE, the SNB, and remember, the saw applies equally well to both easing and tightening cycles.

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