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Fed Taper Brings Us Back to the Future 

Kristina Hooper 

The Upshot 

12/23/2013 

A return to normal economic conditions is now more palpable following the Fed’s decision to start unwinding QE and early signs of a revival in consumer spending, growth and jobs, writes Kristina Hooper.
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Kristina Hooper, US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Sometimes the changes we fear most are the ones that reap the biggest rewards.

The FOMC’s announcement last week that the Fed would begin tapering its quantitative easing program in 2014 could be the signal that better economic times are upon us. It just took us a long time to get there. And we had to work through some of the anxiety over less easy money.

Beginning in January, the Fed will reduce its bond purchases by $10 billion, equally split between government securities and mortgage-backed securities. The Fed also pledged to keep short-term interest rates at current levels until "well past the time that the unemployment rate declines below 6.5%."

Stocks rallied on the news that investors seemed to fear for so long. Indeed, the Dow hit a record high in inflation-adjusted terms last week while small caps were a big beneficiary, rising nearly 4% for the week. Treasuries handled the news well, especially when compared to the visceral reaction they had to taper talk earlier this year.

After the Great Recession derailed the economy for more than five years, we finally seem to be getting back on track.”

A Shot in the Arm

Stocks’ advance on the heels of the taper announcement suggests investors viewed the Fed’s decision as a vote of confidence for the US economy. After the Great Recession derailed the economy for more than five years, we finally seem to be getting back on track. That is, the future that was almost lost from sight as we tried to recover from such a heavy economic blow, can now begin to be reclaimed.

But it’s not just the Fed decision to taper that’s pointing toward progress. The US economic picture has improved considerably in recent months, as evidenced by stronger data. The final reading on third-quarter GDP growth was revised upward substantially, showing that the economy in the quarter grew 4.1% on an annualized basis. It marked only the second time since the recovery began in the summer of 2009 that we saw an annualized reading of 4% or more. Not only was this gain less inventory-driven than the prior release, but also the gain was driven largely by a significant boost in consumer spending.

This improvement in consumer spending can also be seen in the increase in consumer debt in the third quarter. We’re finally seeing a consumer that is re-levering after a number of years of deleveraging. Specifically, there’s been a slight increase in revolving debt, which could be a sign that Americans who were previously cautious about spending are now loosening their purse strings. This makes sense because the US labor market is recovering, albeit with some serious flaws.

Turning Point for Consumers

Today’s personal income report for November also points to better household balance sheets. While personal income rose only 0.2%, wages and salaries actually rose 0.4%. Consumer spending rose 0.5% and the personal saving rate fell to 4.2%.

A Wealthier Mindset

Meanwhile, perhaps an even bigger driver of consumer confidence has been the wealth effect from rising stock prices and home values. Intuitively, the perception among consumers that they’re wealthier makes them more likely to borrow to pay for big-ticket items such as cars, houses and education. In addition, as noted in past issues of The Upshot, consumers are also regaining confidence after taking a hit from the government shutdown.

Further supporting the view that the US economy is returning to normal, the International Monetary Fund upgraded its outlook for the US economy. IMF Managing Director Christine Lagarde cited the recent budget deal in Washington and the Fed’s decision to taper quantitative easing as key factors that have reduced uncertainty.

Looking ahead, we expect US economic growth to accelerate in 2014 and that extreme risks will diminish. While threats remain, we’re optimistic that the economy is on a gradual path towards normalcy.



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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 

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