As US economic indicators continue to disappoint, the Federal Reserve has stepped in for a fourth time, with an extension to Operation Twist. But, as deeper problems within the economy become apparent, some are questioning whether the Fed’s latest efforts can pull the US out of a slowdown.
Looking across the Pacific, recent economic data shows that the US is still struggling to break free of the post-GFC doldrums. Weak employment, consumer spending and manufacturing figures point to ongoing weakness across the US economy, despite a strong start to the year.
The state of the USA
While the US unemployment rate is hovering at around 8.2%, the pace of jobs growth has slowed. From January to March, jobs growth averaged around 225,000 jobs each month - in April and May this dropped to just 73,000.
This comes at a time when other economic indicators, such as consumer spending and manufacturing activity are also showing signs of weakness.
This was initially blamed on the effects of one of the warmest winters on record. In the US, a warm winter traditionally brings forward economic activity such as housing construction and consumer spending, diluting it across a longer period.
However, the duration and extent of the slowdown now suggests there could be other, less seasonal, factors at play. As a result, market forecasts for 2012 GDP growth have been downgraded by almost half — from as high as 4% earlier in the year, down to 2%.
This weakness, and a desire to keep inflation in check, has prompted the Federal Reserve to again step in to help kick-start the wider economy, extending Operation Twist an extra six months until the end of 2012.
This is the fourth measure the Federal Reserve has introduced, following two balance sheet expansions and the first Operation Twist.
Through Operation Twist, the Fed hopes to stimulate the supply of credit, by lowering the term structure of interest rates. The Fed has also maintained its commitment to keep the Fed Funds rate at exceptionally low levels until at least late 2014.
Operation Twist aims to extend the average maturity of the Federal Reserve’s holdings of Treasury Securities, selling or redeeming Treasuries of less than three-year maturity, and buying those with six to 30 years to maturity remaining.
The extension of the program will see a further US$267 billion bonds sold and bought in the longer end of the curve, taking the total amount ‘twisted’ to US$667 billion at the end of 2012.
The objective is to put downward pressure on longer-term interest rates and provide an easing of financial conditions in the US economy. But given the term structure of interest rates in the US is already low, with two-year bond yields at 0.31%, 10-years at 1.62% and 30-years at 2.69% (as at 26 June 2012), some argue that the problems in the US economy have more to do with the demand for credit, rather than the supply.
Households, businesses and investors are less hungry for debt, with many indicating a low desire to take on extra risk in an uncertain economic climate.
It is also argued that slower jobs growth in the US may be structural, rather than cyclical, as the Fed believes. As the growth drivers move away from the construction-fuelled boom of the 2000s, some believe the new natural rate of unemployment may be closer to 6.5%, rather than the pre-GFC level of 5%.
The focus on the US will soon turn to the debt ceiling, which is likely to be breached in late 2012, requiring an extension, as well as the impending fiscal cliff — which threatens to push the country into recession in 2013.
The fiscal cliff in 2013 is the result of two main forces;
- Mandated spending cuts as a result of the debt ceiling negotiations of 2011.
- The expiration of the Bush-era tax cuts introduced in 2003.
Political difficulties and lack of bipartisan support make it unlikely that the fiscal cliff will be resolved before the 6 November Presidential Election. And if Obama is to lose office, action may be delayed until early January.
In any case, the US will need to find a way to smooth the fiscal cliff to prevent a sharp deterioration in the economy in the first half of 2013. And in the long term, significant work is needed to bring the US budget back on a sustainable path. This is likely to be a political and economic priority for 2013 — as without improvement, further credit rating action for the US can’t be ruled out.
Written by Belinda Allen, Senior Analyst at Colonial First State
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