• It remains questionable how well the U.S. economy can fair without the help of government support. This favors a low fed funds rate, for example. The Fed appears to be concerned about the possibility of a relapse and will be unwilling to withdraw stimulus except for a natural unwinding of some of its support programs.
• A major obstacle to growth is the continued lack of credit creation in the U.S. banking system, where weekly loan data continue to show steady declines. There is not “velocity,” in other words; Federal Reserve liquidity is not yet moving out the door from the banking system.
• Growth will be slow to return in part because a large amount of jobs lost are “permanent” job losses. Data from the BLS show that roughly 4 million of the 7 million jobs lost during the recession are “permanent.” (see chart in separate email).
• U.S. consumers are of course in the midst of repairing their balance sheets and this will last years. Consumer spending will be held back by the de-leveraging and other factors such as demographics (the aging population will be leery about spending ahead of retirement. Moreover, they will be more risk averse than before having gone through several shocks over the past decade. This will be reflected in a lower equity risk premium, for example.
• Treasury supply matters, but it matters most in bear markets when investors tend to demand larger concessions. Still, he said the influence of supply is increasing and there is an as-yet unknown limit to how much supply global investors can and are willing to absorb.
• China’s persistent squawking about the U.S. dollar’s reserve status is a continuation and perhaps a hastening of the 7-year diversification idea that has brought the dollar down to 63% of world reserve assets from 70% in 2002. China is not ready to take the mantle:
1. It has no bond market for which to house the world’s reserve assets
2. Its unilateral currency swap agreements with other nations are targeted toward trade, not finance.
3. Chinese companies cannot yet raise money offshore in their own currency. This will stymie globalization of the renminbi.
• That said, the question of our age remains: If the U.S. is backing its financial system, who is backing the U.S. Without an affirming response, there remain risks to the U.S. in the absence of a restoration of fiscal prudence.
So, as you can see, along with many other factors, there are plenty of fundamental factors that can help explain the recent behavior of financial markets.
Disclaimer: This article contains the current opinions of the author but not necessarily those of PIMCO. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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