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3 Powerful Forces Transforming the US Economy

Steven Malin | 17/12/2016
US Presidential Election

Summary

Some of the top factors limiting US growth also hold the key to its future: Fed policy has lost its effectiveness, populism has transformed politics and technology has radically reshaped economic activity. Policymakers and businesses alike must take notice or risk missing the wave.

Key takeaways
  • Several Fed officials now feel that a less accommodative policy stance and a looser regulatory environment would help stimulate the US economy.
  • Structural changes in the economy weaken the Fed’s ability to hit policy targets that often turn out to be wrong.
  • Ultra-low rates have distorted markets, altered the timing of consumer and business spending, resulted in too much cash on balance sheets and curtailed the capital spending they were designed to stimulate.
  • Populist movements will continue attacking monetary and fiscal policies, regulations, trade relations, immigration and environmental policies, and other aspects of government.
  • New technologies are radically reshaping every facet of economic activity, transforming industries and sectors more disruptively than any previous industrial revolution.
  • Not heeding the implications of the modern industrial revolution could lead to major policy errors and unprecedented threats to businesses.

Central bank policies now impede economic growth

Throughout most of the post-crisis period, the US Federal Reserve argued that the United States' weak economic growth, productivity and capital spending were caused mainly by insufficient aggregate demand. In response, the Fed implemented aggressive monetary accommodation to stimulate spending – and, for a while, it succeeded. However, GDP growth soon decelerated and business investment stayed subdued, which indicated that the economic theory the Fed relied upon had proved to be faulty.


Economic growth stays range-bound

Real GDP growth has been modest, but sustainable

Economic growth stays range-bound

Source: Federal Reserve Bank of St. Louis; Allianz Global Investors as at 29/11/2016.



Consequently, several Fed officials in 2016 wrote extensively about how structural changes in the US economy had been interacting with ultra-low interest rates and tougher regulations on banks to make interest rate targeting difficult, reduce the target level of policy rates and restrain real economic growth. Among their key findings:

  • Precautionary savings rose, causing real consumption to not keep pace with real disposable income.
  • Persistently low interest rates encouraged households to postpone consumption and build up precautionary savings.
  • Regulations raised hurdle rates on prospective business investments.
  • The mix of regulatory and economic policies encouraged capital spending outside the United States rather than within it.
  • Low interest rates encouraged corporate leverage – not to finance productive investment, but to finance share buybacks and dividend distributions.
  • Federal Reserve ownership of Treasury securities removed collateral from the repo market used to finance day-to-day operations of businesses.
  • Low interest rates strained pension funding.
  • Mortgage financing became more difficult.
  • Banks chose to restrict some forms of lending in order to protect their equity from potential loan losses.


New fiscal priorities must heed the modern industrial revolution

The Fed's policies and unforeseen structural changes have not been the only factors causing sluggish US economic growth. Growing populist movements are set to at least partially shape a new wave of fiscal intervention into economies – and monetary policy must account for these new influences in the years ahead. These movements reflect a combination of globalization, technological changes, political stalemates and geopolitical crises that have resulted in lower inflation-adjusted incomes and widening of income and wealth disparities.

Moreover, the inexorable development, marketing and implementation of a range of new technologies has already reshaped how businesses are organized – and arguably altered every aspect of economic activity. This chain reaction of technological progression will continue to generate enormous upheaval and opportunity. Not only have modern technologies become disruptive, but they have reduced the need for material inputs, enabled production at a zero marginal cost, made the entirety of human knowledge accessible via the cloud, and made knowledge available to anyone in the world at virtually no cost. These are new technologies that now "crowd-in" knowledge and understanding instead of crowding it out.

Clearly, the pace of adoption of new technologies has never before been so pervasive and rapid. As a result, all households, businesses and governments must adapt to and change with this new, modern industrial revolution or else risk their economic and financial well-being, now and in the future. This has significant implications for the Fed and other central banks: Failing to master the implications of this industrial revolution will not only cause them to miss their policy targets, but push them toward setting the wrong targets.

For more on this topic, read Steve Malin's white paper: "Under the Macroscope: Policy, Politics, and Technologies Scuffle in a New Era".



Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

© 2016 Allianz Global Investors. All rights reserved.
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Steven Malin

Investment Strategist, US Capital Markets Research & Strategy
Steven Malin is an investment strategist and a director with Allianz Global Investors, which he joined in 2013. As a member of the US Capital Markets Research & Strategy team, he is responsible for making weekly US and global asset-allocation recommendations. Steven’s responsibilities also include analyzing global economic, financial, political and regulatory developments; and briefing institutional, retail and retirement clients. Before joining the firm, he was the director of research at Wealthstream Advisors, a private wealth management firm; and an advisor to Aronson Johnson & Ortiz, a quant-based institutional equity manager. Earlier, Steven was a senior portfolio manager at AllianceBernstein, serving institutional, sub-advisory, Taft-Hartley and private clients throughout North America. He also worked at the Federal Reserve Bank of New York for more than 16 years, and during this time he was an officer who held several senior position. Before that, he was the senior economist, founder and director of the regional economics center at The Conference Board. Steven has a B.A. in economics from Queens College and a Ph.D. in economics from the Graduate Center of the City University of New York.

Time to Pay Attention to ‘Trumpflation’

Greg A. Meier | 19/12/2016
Time to Pay Attention to 'Trumpflation'

Summary

With a growing likelihood that Trump’s fiscal policies will be inflationary, the odds of a Fed rate hike are surging, as higher inflation means a faster tightening cycle. So will President Trump find it easier to bring back inflation than factory jobs?

Key takeaways

  • Since the 8 November vote, several major indexes have hit record highs as investors have piled on bets that inflation will pop
  • Higher inflation is not necessarily “bad”, especially if it is caused by higher growth and provided it can be held at a healthy level
  • If enacted, Trump’s proposed tax cuts, trade tariffs and tighter immigration standards could all begin pushing inflation up

For some time, conventional wisdom held that the financial markets would be more comfortable with Hillary Clinton than Donald Trump as the next US president. True to form, on election night, many major indices fell along with Clinton’s chances as the results rolled in. Surprisingly, however, once the election’s results became clear the next day, markets re-priced quickly, seemingly happy to anticipate a future US economy with Donald Trump at the helm. Since then, burgeoning optimism has driven the large-cap S&P 500 Index, the small-cap Russell 2000 Index and the US dollar to their highest levels since at least March 2003. 

Among the forces underpinning the shift is the growing likelihood of rising US inflation: Since the 8 November vote, investors have piled on bets that inflation will pop. The 5-year/5-year breakeven rate – the market-implied average for inflation between 2021 and 2026 – is up from just 1.4 per cent in July to more than 2 per cent, the highest level in more than a year. As a result, bond yields rose violently as prices fell during a widespread bond selloff – not just in the US, but in much of the world. In the futures market, the odds of a US Federal Reserve rate hike are surging, as prospectively higher inflation translates into faster Fed tightening.

It is worth clarifying that higher inflation is not necessarily a “bad” thing for the US or any other economy – especially if inflation is the result of higher growth, and provided that the economy’s central bank is able to hold inflation at a healthy level without letting it get too low or high.

The root causes of ‘Trumpflation’

There are three primary reasons why Trump’s proposed policies, if enacted, could soon begin pushing inflation higher:

  • During his campaign, Trump announced plans for big tax cuts, less regulation and more public spending – initiatives that should foster faster growth and pressure prices.
  • On the trade front, Trump’s proposals to slap tariffs on Chinese goods and renegotiate NAFTA would mean higher import costs for US consumers and businesses.
  • Tighter immigration standards and deportations would generate wage inflation in industries ranging from technology to construction and agriculture.

The economic pros and cons of Trump’s proposals

One can find compelling reasons for Trump to focus on his proposed, inflationary path. For instance, America’s 39 per cent corporate tax rate is the highest in the developed world, and onerous regulations are a perennial complaint among small business owners – the people who employ the bulk of the workforce. From a public spending standpoint, there is also scope for expansion: the US government accounted for just 17 per cent of GDP last quarter, the lowest level on record. In addition, America’s trade deficit ballooned from -0.3 per cent of GDP in 1992 to -2.5 per cent today.

At the same time, there are also compelling arguments to be made against Trump’s proposals. US debt is at a record high and appears set to move higher, which is why Trump’s deficit-financed fiscal splurge will be challenged by many legislators – including conservative Republicans in his own party. Moreover, the “Trump Tantrum” in bond yields could dampen growth; indeed, home mortgage refinancing is already sagging. Meanwhile, the recent run-up in the US dollar is disinflationary for commodities and import prices, which suggests that the markets could be overshooting their assessment of inflation expectations.

Trump won the presidency by rallying support across America’s “Rust Belt”, yet like other elements of his agenda, bringing back factory jobs displaced by technological advances could prove tough. Time will tell if Trump’s policies bring back the right level of inflation as well.

Will Mortgage Refinancing Continue Sliding Under Trump?
Despite low mortgage rates, refinancing activity was already falling – and it could get worse if rates keep rising due to a "Trump Tantrum" selloff in US Treasuries.

Will Mortgage Refinancing Continue Sliding Under Trump?

Source: FaceSet as at 18 November 2016 (mortgage rates as at 30 September 2016).


Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Equities have tended to be volatile, and unlike bonds do not offer a fixed rate of return. Emerging markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates. Bond prices will normally decline as interest rates rise. Below investment grade convertible and fixed-income securities involve a greater risk to principal than investment grade securities. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice. References to specific securities are not intended to be, and should not be interpreted as an offer, solicitation or recommendation to purchase or sell any financial instrument, an indication that the purchase of such securities was or will be profitable, or representative of the composition or performance of any AllianzGI product. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This material is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan. GrassrootsSM Research is a division of AllianzGI Research. Data used to generate GrassrootsSM Research recommendations is received from reporters and field force investigators who work as independent contractors for broker-dealers. Those broker dealers supply research to AllianzGI and certain of its affiliates that is paid for by commissions generated by orders executed on behalf of AllianzGI’s clients. Source of all data (unless otherwise stated): Allianz Global Investors as at November 2016. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Allianz Global Investors is a trademark, registered in various countries throughout the world, including the United States. © 2016 Allianz Global Investors.

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Greg A. Meier

Strategist, US Capital Markets Research and Strategy
Mr. Meier is a strategist and a vice president with Allianz Global Investors, which he joined in 1999. He is responsible for developing research and analysis for the firm’s investment professionals and Sales and Client Service teams, and for conveying the firm’s views to clients. Mr. Meier’s work focuses on global capital markets, macroeconomics, monetary policy, fiscal policy and retirement issues. He was previously a performance analyst and a financial writer with the firm. Mr. Meier has 15 years of investment-industry experience. He has a B.S. in business administration from the University of Montana and an M.B.A. from the University of Washington.
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