LAST YEAR was dominated by recurring fears over a disorderly disintegration of the euro. In 2013, the main focus of the markets will be the US economy – hopes of resurgence mixed with fears of a new crisis. Although 2012 was disappointing, with growth expectations successively downgraded, the financial markets have remained surprisingly resilient, with stock markets rising in both the US and Europe. Fears that the euro would disintegrate, or that the US economy would fall off the “fiscal cliff”, failed to materialise. Aggressive stimulus injected by the major central banks has sustained the markets, while the dangers of an ever-growing addiction to massive injections of cheap money have been shrugged off.
The new year has started on a positive note. Barack Obama’s victory in the November US presidential elections has given him the clout to broker a deal that avoids the risk of an excessive fiscal squeeze. The compromise between the president and the Republican majority in the House of Representatives has triggered further increases in equities and other risk assets in the first few days of 2013.
But the deep US political impasse over taxes and spending will persist, and could unsettle the markets. The US has again hit its borrowing limit and, unless the politicians agree a new limit in the next few weeks, the stalemate could lead to government paralysis, technical default and a further loss in credit rating. While the markets are cautiously hopeful common sense will prevail, it would be unwise to disregard the danger that the stand-off could persist. Nevertheless, the economic figures continue to signal a modest US recovery.
While inadequate by historical standards, the US upturn is gradually strengthening and may prove more sustainable this year than in other global regions – not just Europe. US home prices showed an annual increase of 4.3% in November 2012. If the housing market continues to improve, US consumer confidence will strengthen, making it easier for demand to grow faster. We are also seeing a steady, albeit slow, improvement in the labour market. The US economy created 155,000 new jobs in December, bringing the total increase in employment during 2012 to just over 1.8 million. The jobs created were spread across most sectors, pointing to a balanced recovery. The US jobless rate remained at 7.8% in December, unchanged from November, but a marked decline from 8.5% a year earlier.
But the Federal Reserve, which regards the US upturn as unduly slow and is determined to reduce the unemployment rate further, will continue to buy $85bn (£52.8bn) of mortgage-backed securities and government bonds each month as part of quantitative easing (QE3). The Fed also plans to keep interest rates at close to zero, at least until the US unemployment rate falls below 6.5%, and has indicated that rates can be expected to stay at their current level until 2015. The Fed’s massive stimulus, which implies purchases of an additional $1tn in long-term assets in 2013, will sustain asset prices in the short term, and will support a US economic revival.
But QE3 creates longer-term dangers: bubbles, financial distortions, future inflation and rising trade tensions, since it is seen as an attempt to engineer a dollar devaluation. Some members of the Fed’s Open Market Committee have signalled concern. If a change in US policy becomes necessary, probably in 2014 or 2015, equities and other risk assets could suffer a major setback.
In the eurozone, the ECB’s “bazooka”, known as OMT (Outright Monetary Transactions), has continued to stabilise the financial system. Previous pressures on sovereign debt markets in the periphery have eased, and yield gaps versus German bunds have shrunk further. But the real economy is still worsening. GDP in the eurozone as a whole has recorded a decline in 2012, and expectations that 2013 will see a return to positive growth are being revised down. Our new forecast indicates zero eurozone growth in 2013, but some analysts are predicting a further GDP decline this year. Unemployment is continuing to increase; the jobless rate, which hit a new all-time high of 11.8% in November 2012, could increase towards 12.5% during 2013.
Large gaps in performance between core and periphery will persist. The employment situation is most dire in Spain and Greece; both have overall jobless rates of about 26%, with youth unemployment rates (among people under 25) of 55%. While this creates serious tensions, the threat to the euro is no longer immediate, and this is giving the politicians precious time. The Italian elections due in February, and the German elections due in September, will play a critical role in determining the euro’s future.
As expected, the UK returned to positive growth in the third quarter of 2012, with GDP increasing by a relatively strong 0.9%. The figure was distorted by the Olympics and by the Queen’s Diamond Jubilee, which depressed output in the second quarter. There are many unresolved questions over recent UK GDP figures, particularly the contrast between weak output and robust increases in jobs. But it is clear that economic performance is inadequate, with minimal growth only in the last two years.
Public finances are under pressure, and the deficit-cutting plan will take two to three years longer than initially envisaged. While this may lead to the UK losing the AAA credit rating, such an outcome is not a foregone conclusion if the chancellor can sustain confidence. The appointment of Mark Carney, currently governor of the Bank of Canada, as the next Bank of England governor from 1 July 2013 was a welcome surprise. It was seen as coup for George Osborne, and many expect Carney to be a breath of fresh air. But the transition to a new regime could be unsettling. ?-