The latest round of economic releases continues to confirm a picture of a strengthening and broadening activity suggestive of a self-supporting expansion. While chronologically old, the current state of the economy in many ways is exhibiting signs consistent with the early stages of a business cycle that is far from reaching its peak.

Conditions that argue for a better, more sustainable, economy going forward are many: the pace of hiring has picked up significantly, while disposable income, confidence, and other consumer fundamentals continue to improve. Lending to both businesses and households is increasing. Corporate profits are also showing renewed growth, helping to push the stock market to new highs. Finally, the age of fiscal restraint is also coming to an end, as improving tax revenues allow for more government spending. These all are characteristics of a normal business cycle upturn and expansion.

We expect greater aggregate spending to drive the engine of growth. In the early stages of recovery, the biggest obstacles to preventing faster economic growth were the ongoing credit constraints that remained after the financial crisis and the overhang of built-up debt. The picture is markedly brighter now, as corporate and household balance sheets, by many measures, are in their best shape in over a decade. And more evidence points to cyclical mechanisms, typically seen in the beginning of a U.S. expansion, beginning to click into place.

Historically, household financial strength has been a prerequisite to stepped-up gains in spending. The lag until the economy benefits can be long, as gains in household sector net worth, savings in the household balance sheet, and improved household finances all need to happen before a resultant pick-up in consumer spending. For the business sector current developments are also characteristic of early to mid-business cycle, not later stage, expansion territory. Hiring, capital investment, buybacks, dividend increases, acquisitions, and the funding of new businesses are all on the upswing, but not as much as one sees later in an expansion cycle, when demand grows stronger. Spending from consumer and corporate sectors, which account for some 80% of the economy, now appears to be firing up, and with financial positions increasingly stronger, improved economic growth is likely to be sustained.

With the economy likely to gain speed in the quarter ahead, further declines in the unemployment rate and somewhat higher inflation are expected to prompt the Fed to begin raising the federal funds rate by mid-2015. However, a gradual return toward more normal levels should be viewed as a healthy development in the maturation of a business cycle, indicating that economic growth is more self-sustaining and in less need of support. Given the remaining slack in the labor market, the global economy struggling, and commodity prices weakening, inflation should remain relatively modest, giving the Fed the freedom it needs to move cautiously and incrementally in the transition toward more normal levels of monetary policy.

The current expansion has already lasted longer than the average, but business cycles do not die of old age. Indeed, the natural tendency is for economies to grow, and an expansion can last a long time before the excesses or imbalances that ultimately sow the seeds of the next economic downturn reach a tipping point. We believe we are far from that point, which means the potential for an extended business cycle, and further stock market gains, is great.

THE FED The policymakers of the Federal Reserve’s Federal Open Market Committee (FOMC) updated their projections for the year-end federal funds rate. At the end of 2015, the median expectation of the federal funds rate is 1.375% (higher than the previous projection of 1.125% in June). This expectation should be taken with a grain of salt, as each of the current 17 members who make projections are widely diverse in their expectations for inflation, the level of economic growth, and how much slack there is in the labor market. These diverse views result in projections having a range of more than 2.5 percentage points that are dispersed between two members who believe that the rate will be unchanged from the current level of 0.25%, to one member thinking the federal funds rate will be as high as 3.875%. Clearly, there is no consensus among the members. The next projection will be in mid-December, and by that time there should be more of an agreement of when the first rate hike will occur and how much rates will move over the course of the year.

As expected, the FOMC reduced another $10 billion from their monthly purchases of government securities. They are now purchasing just $15 billion per month (it was at a peak of $85 billion last December). The FOMC is expected to announce the termination of the purchases at their next meeting on October 29th. The $4.2 trillion that they have accumulated with the various quantitative easing programs (QE) is expected to stay at that level for the foreseeable future, helping to keep downward pressure on short-intermediate interest rates.

EMPLOYMENT The labor markets continued their streak of 47 consecutive months of increases in the number of workers added to the payrolls. The August release came in at a tepid 142,000 following six consecutive months of increases that exceeded 200,000. Although one month does not make a trend, this decline has taken the wind out of the sails of those expecting a marked increase in employment gains in the second half of this year. Considering the strong gains earlier in the year, the August pullback is well within historically normal results for this metric.

At the same time, the unemployment rate ticked back down to 6.1%, matching the lowest level of this cycle. Unfortunately, it fell due to a meager increase in the number of those employed and a large drop in the labor force (denominator). Average hourly earnings have increased 2.1% in the past year; they have hovered around 2.0% for the past three years.

INFLATION Consumer prices have started to retreat after the second quarter run-up that put the yearly change in the consumer price index at 2.1%, just ahead of the Federal Reserve’s target rate of 2.0%. The most recent release of this index fell for the month of August. This is the first decrease in nearly 1.5 years, putting the yearly change at 1.7%. Gasoline prices have been the major drag on the index. The 34 cent decrease in the third quarter more than off set price increases in food and shelter.

The recent trade-off helped alleviate the fear that some investors had of an inflationary surge (the yearly change in the Consumer Price Index [CPI] popped from 1.3% in March to 2.1% in June). At the time, the Federal Reserve acknowledged the strength in prices, but cautioned against reading too much into the data, dismissing it as statistical noise. The Fed believed that the fundamental issues (such as moderate economic growth and mild increases in income) would keep inflation below target. It appears as if they were correct in that assessment. The ability of the economy to keep a tight lid on price increases allows the Fed to have patience before it initiates its first increase in the federal funds rate.

THE DOLLAR The significant appreciation of the dollar in the third quarter of this year (up 6.7%) now places it at a five-year high. This is a drastic change following 1.5 years of trading in a relatively narrow range against a basket of other currencies. The move has pushed the greenback to a two-year high against the euro.

This move has been brought on by some strong fundamental news: the U.S. economy is growing fast enough for the Federal Reserve to contemplate raising the federal funds rate next year. For foreign investors that is very appealing, which increases demand. For the domestic economy, it can make imports cheaper (most noticeably gasoline, a global commodity priced in dollars) and exports more expensive. The impact on the economy will probably be small since the U.S. is insular to global events (it is a relatively closed economy). Both exports and imports account for about 30% of GDP. That is about half the level of Canada and about a third of the level of Germany.


Japan, the third largest economy in the world, has been plagued with poor economic growth since the stock market crashed in 1990-1992 and the real estate bubble popped in 1991. Economic growth in Japan has been much slower than in most other industrialized countries, and has resulted in poor stock market returns.


The currency has also performed poorly since the high-flying economic strength that was exhibited in the 1990s.


Consumer price pressures have been anemic since the 1990s. The main reason for the increase in recent months is due to the new consumption tax, which is included in the inflation calculation.


“Abenomics” is the term given to Prime Minister Abe’s policies to kick-start the economy. There are three “arrows in the quiver,” as it is often called: increased monetary stimulus, increased fiscal stimulus, and improved structural reform. These policies should help improve Japan’s economy and help reduce the extraordinarily large amount of government debt that has been brought on by social welfare spending and the lack of economic/industrial growth since the early 1990s.



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