The longer-run fundamentals for risky assets are likely to remain positive even as short-term dynamics regain their balance.
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The swell of market optimism and risk appetite in recent months reflects the increased credibility of two ideas. First, that US growth will accelerate over time and lead a global recovery. Second, that central banks, including the Fed, will (eventually) raise rates and exit from the strong stimulus measures of recent years. The broad level of acceptance of these views in the market is likely to continue to fluctuate depending on the immediate flow of economic data. It is no accident that, since November, global industrial production momentum has swung from -1 percent toward a second quarter peak near 7 percent (above trend), and at the same time, the market’s concerns have changed focus from tail risks to the types of problems that come from better growth and higher interest rates.
US job vacancies to unemployment ratio
enlargePause or Peak?
The key now is whether global growth momentum is set to pause or peak. Credit Suisse strategists forecast that a slowdown is near, but a sharp decline in growth from there is unlikely. More of a pause than a peak is expected, but the shift might still change the market’s mood, as growth is no longer accelerating and consistently beating expectations. In fact, there are hints in the economic data and in market price action that this has already begun. US nonfarm payrolls grew on average by 200,000 per month in the fourth quarter of 2012, but January’s number dipped to 157,000. The Job Openings and Labor Turnover Survey (JOLTS) data showed a small decline in jobs vacancies at year-end. While initial claims confirm ongoing improvement in the labor market, the growth of labor income in the first quarter is likely to moderate compared with the final quarter of 2012.
Spending Outlook:
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By GlobalDataThis imperils the spending outlook, which is already threatened by the payroll tax increase. According to the report, January real retail sales dipped slightly following a strong gain since last summer. Further risks come from rising gasoline prices and budget sequestration, which could cut spending by as much as 63 billion US dollars (over the year), about half the size of the drag from the payroll tax increase. In reality, we don’t expect the effect from sequestration to be that big (it should be temporary), but the lack of focus on these cumulative drags to income and spending is symptomatic of an ebullient market.
Global Risk Appetite and IP Momentum
enlargeAround the World:
There is optimism about medium-term Chinese growth, which seems well supported by domestic policy. In Europe, leading indicators suggest that growth is set to improve further. Japanese industrial production has plenty of room for a strong rebound in the coming months as well. Global risk appetite has fallen 1 point to 2.8, pulled down by underperforming European peripheral equities. Credit risk appetite has been dipping too, pulled down by underperforming financial corporates. Price performance has also been weaker lately in parts of the non-agency mortgage market. And there has been downward pressure on steel prices, which sometimes indicates slowing of growth momentum.
Effect on Equities:
Five consecutive weeks of mutual fund inflows into equities totaling 43.8 billion US dollars are a symptom of both longer-term bullishness and short-term optimism. The longer-run dynamics will likely remain positive, but the short-term dynamics look set to regain their balance as the growth rebound settles into something steadier.
