After a disappointing start to the year, improvement in a wide range of economic data has made us more confident not only in a stronger second quarter, but also in the fact that the foundation for a sustained period of moderate growth appears to be in place. Even though GDP in the first quarter was revised into negative, for the first drop since 2011, underlying strength in the economy is certainly more positive than the data suggests.

Despite earlier headwinds, private domestic demand managed to maintain most of its momentum in the first quarter, rising by 2.1% year over year. Additionally, given the recent pickup in job gains and the improvement in household balance sheets, there is every reason to expect demand to increase in the months ahead. With consumers providing a steady drive, economic activity should build on itself and become reinforcing – encouraging more production, business investment, and improvements in housing, which should add to growth in the second half of the year.

Fundamentals relating to the consumer are well supported. Payroll employment has increased now for 51 months, and it is almost certain to move above its prior peak this month or next. Faster job growth should continue to support improving wage growth, and with inflation subdued, boost real incomes, which should provide greater purchasing power to the beleaguered American consumer. At the same time, household balance sheets are now strong enough to support increases in debt, and banks in turn are continuing to ease standards, hoping to ignite further borrowing.

A period of stronger investment growth would also sit comfortably with the loosening of lending criteria by banks. In fact, by the end of April, bank loans to businesses rose by an annualized rate of 16.0% over the past three months as compared to the three months prior, indicating that the steady slowdown in private investment growth in the past two years may soon come to an end. Now that some firms are reaching capacity constraints, they have little choice but to buy more equipment to raise production. Exports, too, are expected to continue to be supported by stronger international demand in key markets. While the slowdown in emerging markets continues to weigh on global growth, in this regard, a healthier Eurozone is more important to U.S. exporters than a weaker China.

The recent retrenchment in yields reflects, in part, deflationary impulses abroad and a flight to quality (due to geopolitical concerns, among other issues) rather than a signal by markets of potential economic weakness ahead. The good news is that lower bond yields have also lowered mortgage rates and should support a much-needed rebound in the housing market. Housing data has already shown signs of turning a corner, with home sales, housing starts, and building permits rising in April. As firms expand payrolls and household formation continues to slowly build, we believe the housing picture will improve.

We expect a continuing buildup in economic momentum, evidenced by an improving labor market and gradually increasing price pressures, to allow the Fed to bring bond-buying to an end as scheduled later this year. The first rate hike is not expected until the middle of 2015 and is likely to be only gradual. However, the Fed will likely remain accommodative and cautious on its exit plan; its decision to tighten will be based on the improvement in the economy and not on the calendar.

While the recent strength in domestic indicators is welcome, markets have taken a more cautious stance, with stock prices moving sideways as bond markets have rallied. We expect sentiment to eventually return to equity markets, though returns may be volatile in the near term. Economic improvement, however, should help boost corporate profitability and ultimately stock prices over the long term.

THE FED Ever since the makers of domestic monetary policy began the asset purchase program (quantitative easing) back in 2008, they have been eager to find a way to exit this nontraditional method of providing stimulus to the economy. Earlier this year, they began tapering their monthly purchases of treasury and mortgage bonds – at the current pace, additional purchases should conclude by the fall. In regard to the portfolio, the Fed has been reinvesting all coupon and principal payments. Since 2011, the belief had been that the Fed would stop this reinvestment, allowing the portfolio to gradually shrink before it initiated raising interest rates. However, on May 20, William Dudley, president of the Federal Reserve Bank of New York and one of the most influential members of the Federal Open Market Committee (FOMC), stated that the Fed should keep reinvesting in its mortgage portfolio until after it begins to raise interest rates. Doing this will help keep mortgage rates low, which would benefit the beleaguered housing market; it will allow the Fed to move off ZIRP (zero interest rate policy) sooner; and it will provide greater monetary policy flexibility in the future – as the Fed will be able to cut rates if weaker economic growth requires immediate stimulus.

EMPLOYMENT Labor market conditions are improving significantly after the winter lull. The April employment report showed broad-based improvement, a marked change from a couple months of weak job reports at the beginning of the year. Additionally, upward revisions to the previous month’s report suggest the economy is stronger than formerly thought. This is reassuring and rekindles a confidence that the economy can break out of the long-standing muddle that pervades the current situation. The average monthly job gain in five of the past seven months (excluding January and February) is an impressive 245,000.

The April nonfarm payrolls rose 288,000, the best monthly showing in more than two years. The unemployment rate plunged to 6.3% from 6.7% – a new cycle low and its lowest level in more than five years. That being said, we may not want to read too much into this as the drop was due to a decrease in the workforce (the denominator in the unemployment rate equation), which may be due to the expiration of extended unemployment insurance benefits. Despite the improvement in payroll gains, employees do not have bargaining power for better wages. The average hourly earnings increase over the past 12 months is a meager 1.9%, about the same as the inflation rate of 2.0%.

INFLATION Increases in consumer prices have gained momentum over the past two months. The yearly change in consumer prices has jumped to 2.0%, which is a noticeable paradigm shift as this rate was just 1.1% two months ago. At that time, there was little expectation of inflation almost doubling in such a short time frame. Against the backdrop of declining global inflation (Europe is fearful of deflation setting in), this shift becomes even more curious. Domestically, there has been a substantial increase in food prices (meat, poultry, and eggs have increased 6.5% over the past year due to the drought in the West), gasoline prices are up 2.4%, and housing has increased 2.5% – all during the same time frame.

The Fed is not expected to change monetary policy based on this recent increase. The Fed’s preferred measurement of inflation, core personal consumption expenditures – which excludes food and energy prices and has a smaller attribution to housing costs – is up just 1.4% and is well below the Fed’s target rate of 2.0%. All this slack in the labor market has Fed officials believing that inflation cannot get out of control.

EUROZONE The past several years’ worth of recessions, sovereign debt crises, instability in the banking system, and austerity have served as a collective drag on economic growth. After recovering from a double-dip recession, economic growth has advanced just 0.5% in the past year, placing total economic output at 2.5% below the peak prior to the Great Recession (the United States is 6.0% above the previous peak). The unemployment rate remains stubbornly high near 12.0%, and some countries in the southern part of the continent have unemployment rates exceeding 25.0%. Inflation has fallen to just 0.7%, and the European Central Bank (ECB) is committed to the resumption of stimulating the economy to increase inflationary pressures and economic growth.

Despite being sluggish at getting back on the economic track, growth is headed in a positive trajectory, albeit slowly. Rebounding from the crippling sovereign debt crisis (Greek 10-year yields are just above 6.0%; two years ago, they were above 35.0%), the manufacturing sector has been improving for more than a year. The ECB’s use of unconventional policy measures is expected to go far in the continuation of turning many of the long-standing headwinds into tailwinds.


Economic growth in the Eurozone has been expanding since the end of the recession, but disagreements on how to resolve many of the economic, banking, and sovereign debt problems have plagued the recovery.

The pace of economic growth varies between countries; generally speaking, the northern, more industrialized countries have had better economic growth since the end of the Great Recession.


This variance in economic growth has had a direct link to the unemployment rate in each of the countries.


The good news for the Eurozone is that the sovereign debt crisis appears to be a problem of the past.


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