There is increasing evidence that the global economy is shifting into a much lower gear in the first part of 2014. In particular, US evidence is mounting that the economy slowed significantly at the start of this year. Retail sales released this week painted a much less upbeat picture of the US consumer, as November and December sales were revised quite a bit lower and January sales disappointed as well. The three-month change in core retail sales in January fell to -1.0%: the lowest level since 2009. This means that Q4 GDP growth is likely to be revised down to 2.0-2.5% instead of the initial print of 3.2%. It seems that Q1 GDP could be around 2% or even lower. While some of this is likely to be weather related it also reflects some genuine slowing (more on this below).
This week, the Fed’s new chairman Janet Yellen said that it would take a notable change in the outlook for the Fed to stop the tapering course. As we have argued for a while, the bar for halting the process is quite high. Janet Yellen said in her testimony on Tuesday that, ‘We have been watching closely the recent volatility in financial markets. Our sense is that at this stage these developments do not pose a substantial risk to the US economic outlook. We will, of course, continue to monitor the situation.’. With the retail sales report, the accumulation of weaker data (including a sharp fall in ISM and soft payrolls) is starting to paint a new and weaker picture of the US economy, which might begin to make the Fed consider whether it needs to reduce or halt the tapering of asset purchases.
In particular, the weaker consumer picture is likely to be on the Fed’s radar screen. Consumption is the real engine of the US economy. When consumers spend, businesses raise production and increase investment and hiring. Weak personal spending (driven by services) in summer 2013 was part of the reason the Fed postponed its tapering decision. It is easier to see through a weak ISM, which is a production indicator, whether the underlying demand engine of the economy is still strong. However, when the ISM is weak and final demand is sputtering as well, it is a bigger concern.
The next FOMC meeting is on 19 March. At this point, the Fed will have more data to gauge what is going on in the US economy. Unfortunately, the data is likely to continue to be distorted for some time as the bad weather is continuing in the US. Hence, the Fed will be flying a bit blind going into the next meeting. It is likely to be a close call whether or not the FOMC alters the tapering course. However, it seems more likely that, as a precautionary measure, the Fed will step to the sidelines until visibility is clearer and it regains confidence that the outlook of a strengthening recovery in the medium term is still unfolding underneath the short-term fluctuations.
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