Economic update Jan 27 2012
There are some signs that the US economy is turning a corner. Real GDP rose by 2.8% (annualized) in the fourth quarter of 2011—the best showing since Q2 2010—but still relatively weak for a recovery. Key here was personal consumption which rose by 2% in the quarter vs. 1.7% in the third quarter. Note, however, that the increase in consumption was helped by a reduction in the savings rate as opposed to a notable increase in income. This source of consumer spending is clearly unsustainable. In this context the deleveraging process of American households will probably be the most important factor that will determine the trajectory of consumer spending and thus the economy in the coming few quarters. Note that the sharp decline in the debt-to-income ratio has brought that important indicator very close to its trend line (Chart). Some 60% of the decline was due to write-offs, another 20% due to an increase in income (mostly transfer payments) and only 20% was due to real deleveraging via actual reduction in debt.
While we have seen US consumer credit rising for more than a year, all the increase was in student loans, provided by the government which was nothing more than another form of stimulus. The good news is that recent months have seen some acceleration in credit growth in the non-student component. That is a very important development. Note that by 2013, the government will turn from a net positive to the economy to a net negative (probably the main reason behind the Fed’s announcing that it is not expecting to raise interest rates until 2014). And that’s when the consumer will have to take over. Any improvement in credit conditions by then should be seen as an important step in the right direction. What might help here is the fact that delinquency rates on credit cards in the US are back to pre-recession levels.
Turning to the European situation, the focus of course is on Greece and to what extent it will be able to reach an agreement with its private sector lenders. The likelihood is that some sort of an agreement will be reached—a factor that should lead to at least a short-term rally in the market. As we expected, we are getting very encouraging news from the bond markets in both Spain and Italy. Italian 10s are at 5.8%, down from 6.06% at the start of the week and roughly 7.3% in November. Spain is at 4.91%, down from 5.38% at the beginning of the week. This is not to say that everything is ok in the zone, but the ECB’s efforts via direct bond buying and its 3-year credit facility to commercial banks are so far working.
By Benjamin Tal