The Federal Reserve Stays The Course…5/24/13

Chairman Ben Bernanke’s signal that monetary policy will remain loose gave investors some confidence this week that no abrupt monetary policy changes will hinder the economic recovery.  Following a run of upbeat U.S. economic news, largely related to housing and jobs, there had been talk in the markets that the Fed may soon put a brake on its super-easy monetary policy, which has boosted liquidity in financial markets over the past few years.  The Fed is currently making $85 billion in bond purchases every month to encourage lending and spur the U.S. economic recovery. Though a number of economic indicators have improved, the U.S. economy isn’t posting historically high growth rates and unemployment is relatively high above 7 percent despite consistent falls in recent months. However, Bernanke said that keeping interest rates low for a long time can unbalance the financial system, he warned that a change in policy now would “carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.” For now, it appears there will be no substantive changes in monetary policy until GDP growth and job creation both improve.  This commitment from the Federal Reserve to stimulate growth will remain a positive factor for equities for the foreseeable future.

Durable goods orders rose by more than expected at 3.3% month-over-month in April, above the 1.5% increase forecast by economists surveyed by Bloomberg, though March’s 5.7% drop was revised to a 5.9% decline. Excluding transportation, orders exceeded expectations, rising by 1.3% in April, the first gain in three months and above the 0.5% increase forecasted, and March’s figure was also downwardly revised to a 1.7% decline from an initial 1.4% decrease. Also, orders for non-defense capital goods excluding aircraft, considered a proxy for business spending, came in north of forecasts, gaining 1.2% in April, compared to the 0.5% increase that was projected, after an upwardly revised 0.9% in March, versus the initially reported 0.2% gain.

China & Japan Economic News:  Japan’s stock market experienced one of its largest pullbacks in decades this Thursday as the Nikkei Index plunged 7.3 percent.  However, muted stock declines in the U.S. and Europe show that investors around the globe viewed this as an isolated incident and a short term market correction.  Japanese stocks are up over 60 percent since November 2012, which was around the time policy makers began to hint at adopting a bond buying program to spur economic growth.  The actual bond buying program in Japan did not start until April 2013, but speculators and short term investors that bet on Japanese stocks seem to have got this bet right.  Japan’s economy grew at an annualized rate of 3.5 percent in the first quarter of this year, the fastest pace in years.  The weaker Yen is attributable to at least half the growth in the recent quarter (the yen has dropped 30 percent against the dollar and 37 percent against the euro since August 2012).  Although the bond buying program just started last month it is still too early to declare it a success in Japan, which has been in a deflationary slump for over two decades and nominal GDP has not grown in decades.  Interest rates have been stuck around zero and there has been no control of the fiscal deficit.

The Yen’s slide poses a direct threat to other Asian countries trade surpluses as a cheaper yen makes Japanese exports more competitive in the global market.  After years of soaring wages, China is beginning to feel the effects of losing exchange competitiveness which was evident in the slowdown in factory orders in China this May.   A stronger Yuan (Chinese currency) and weaker yen make it harder for China to export goods to Japan, which may add strains on the neighboring countries trade relationship.  Although the appreciation of the Yuan and the recent decline in Chinese manufacturing has caused some concern, most economists are keeping growth targets north of 7.5 percent for 2013.   Many economists attribute the recent slowdown in factory orders to seasonality and destocking by manufacturers.