INTERNATIONAL

UNITED STATES
Is a Slowdown in the Offing?
In the absence of potential tail risk events/severe shocks and externalities, the
rate of GDP growth in the US should eventually rebound in the coming quarters.

- Dr. IVO PEZZUTO, Global Markets Analyst, Management Consultant,

Economics and Management Professor
Author of the Book Predictable and Avoidable ISTUD Business School and
Catholic University of the Sacred Heart. Milan, Italy

44 | The Global Analyst | JULY 2015

he second estimate of first-quarter of 2015

GDP of the US economy shrank at a 0.7 per
cent annualized rate. This contraction proved
to be a bit less than expected (i.e. 0.9 per cent
on an annualized basis to start 2015). The initial estimate of Q1 2015 GDP, released April 29, showed
the economy grew 0.2 per cent to start the year, but well
below then-consensus expectations for a 1 per cent increase. Industrial production has been affected by a
strong US dollar and sluggish global growth, however,
business confidence and consumer confidence indicators
and other indicators seem to suggest that the surprise Q1
contraction will not last much longer despite the fragile
US and Eurozone recovery.
A number of factors seem to have contributed to the
Q1 2015 GDP contraction, among these notable ones
are:
The harsh winter conditions;
Dockers strikes all across the West Coast;
Increased trade deficit due to a stronger dollar which
has allowed American consumers to purchase a larger amount of the depreciated foreign-made goods;
Manufacturing has been undermined by the buoyant
dollar, whose 12.1 per cent appreciation against the
currencies of the United States main trading partners since last June has eroded overseas profits of
multinational companies. Cheap oil and a strong
dollar, while beneficial to consumers, are putting serious pressure on manufacturers.
Lower increase in domestic stockpiles of goods. Domestic inventories decreased due to a pickup in business activity, the results of which are expected to reveal themselves in Q2;
A slightly weaker-than-expected consumer spending;
Decreased investment in the energy sector following
the drop in fuel prices (lower crude prices triggered
a partial freeze in the shale boom). Capital spending in oil field exploration and drilling slumped 48.6
per cent in Q1, the greatest decline since 2009. The
stronger dollar and reduced capex spending by oilfield firms combined with a harsh winter and softer
global demand contributed to slow U.S. growth at
the start of the year.
Slowing exports, non-residential fixed income investment and local government spending
Corporate profits also fell in the first quarter
Nevertheless, in the absence of potential tail risk events/
severe shocks and externalities (i.e., Grexit or potential Eurozone political and social tensions, further geopolitical issues related to Russia/Ukraine, or potential
crises affecting the Emerging Markets, etc.), the rate of
GDP growth in the US should eventually rebound in the
coming quarters. An improving labour market is among
reasons consumers may be more willing to spend in the
next quarters if the economy continues to improve and

Is a Slowdown in the Offing?

there will be no negative impact of a potential rate hike
by the Federal Reserve.

A revival is not far off, though

Gallups US Economic Confidence Index registered at -9
for the week ending June 7, the sixth straight week the
index has been at or below -5. (Gallup 2015). Based on the
latest forecast on the US Economy by Oxford Economics,
it seems quite unlikely that the Federal Reserve will commit itself in June 2015 to a specific rate lift-off date (the
timing and pace of rates lift-off; Fed in its meeting on June
17 did not press for rate hike while sounding cautionary
about GDP growth), but consumer spending is expected
to strengthen through the rest of the year as faster wage
growth, lower oil prices, and upbeat confidence lead
consumers to spend more. Furthermore, increased wage
growth, historically high affordability, and a slow release
of pent-up demand are expected to underpin a stronger
pace of activity in the housing sector. Lower oil prices, a
stronger dollar, and slow global growth will continue to
drag on business investment, but in the coming quarters
the impact of factors will diminish and domestic activity
will probably strengthen. Lower energy prices will continue to weigh on headline inflation, while core inflation
will remain well-anchored.
With real GDP growth averaging 2 per cent towards the
end of the year, the unemployment rate hovering close to
5 per cent and inflation moving back toward 2 per cent,
it is likely to expect a potential rate hike by the Federal
Reserve in September 2015 or December 2015 (policy normalization), in the absence of major risk events/severe
global shocks, externalities, slow recovery and subdued
inflation, or lower productivity growth.

Needed a New Deal to end the Greece Crisis

Financial markets, however, can be quite volatile when
hit by fears of potential economic and financial crises
(i.e., Grexit - S&P has recently downgraded Greece to
CCC, with negative outlook and IMF payment has been
deferred), potential contagion risks, or geo-political tensions in various areas of the world. All these elements
might have a sudden impact on the emotional reactions
of investors who might turn immediately risk averse
due to the rising uncertainty, markets interconnectedness and complexity. ECB President Mario Draghi said
in April 2015 that the euro area is better equipped than
it had been in the past to deal with a new Greek crisis,
but warned of uncharted waters if the situation were to
deteriorate badly. No one can fully predict the unintended geo-political, economic and social consequences
of a potential Grexit scenario.
In the last six months, that is, since the beginning of the
new Greek crisis in 2015, we have not yet seen a significant emotional or panic reaction of international investors about a potential Grexit event (Exit of Greece from
the Eurozone). This apparent calm reaction of the financial markets can be probably related to the higher confidence investors have in Greeces major creditors ability
The Global Analyst | JULY 2015 | 45

Is a Slowdown in the Offing?

(i.e. IMF, ECB, and EU Countries) to
figure out a sustainable agreement to
keep Greece in the Eurozone at any
cost, or at least, to be able to mitigate
the negative effects of a potential
Grexit event. It could be also due
to the fact that the international private financial institutions currently
have only a marginal exposure to the
Greek debt.
Whatever will be the outcome of
the current Greek crisis, in order to
avoid in the future additional potential systemic risks (i.e. liquidity, solvency, banking, political crises) and
potential spillorver effects, and to
revamp long-term economic growth
and prosperity in the Eurozone, it is
crucial to reach an agreement to prevent the further deterioration of the
economic and financial situation in
the Country and to keep Greece solvent in the long term. Furthermore,
It would be also beneficial for the
European leaders to envision and
implement in the coming years (the
sooner, the better), a stronger and
more cohesive integration process
and a new deal (i.e., revision of the
Eurozone Treaties) in order to minimize the risks of potential durable
spillover effects to the rest of the euro
zone or global economy in case of a
potential default of a member state.
The new deal should probably include the following ambitious and
daring policy decisions (political
courage) while trying to avoid any
potential risk related to moral hazard:
Allow a more pro-active use of
the crisis resolution mechanism/
fund and of the regional institutions and facilties to prevent crises (i.e. ECB, European Stability
Mechanism, European Investment Bank, or the creation of a
European Monetary Fund), i.e.,
before the default occurs;
Assure proper capital controls
policies and bail-in regime for
banks crisis resolution and loss
absorption
Assure full risk sharing mechanisms among member states for
QE programs and a common fiscal backstop for solvency/sover46 | The Global Analyst | JULY 2015

eign debt crises;

Assure full integration in the
Euro zone of the fiscal (i.e. the
assurance of a fiscal backstop
and fiscal transfers), economic,
monetary, banking, capital markets, financial, and political systems;
Introduce a single deposit-insurance mechanism covering all
banks in the Union;
Assure adequate powers for the
single supervisory mechanism
in the Euro zone and effective
and forward looking macroprudential regulation of all financial
institutions (i,e. banks, shadow
banking, investment funds,
hedge funds, asset management
firms, and insurance firms), as
well as, harmonized bankruptcy
laws, accounting rules, and fiscal
criteria in the region, and a single and fully empowered crisis
resolution authority;
Implement a common mechanism to support job flexibility in
countries with high unemployment;
Introduce clear policies and resolution criteria for managing
bank crises, banks recapitalizations, collateral haircuts policy,
balance of payments imbalances, asymmetric shocks, and debt
restructuring solutions in case
of fiscal and debt restructuring/

solvency crises. Thus, it is important to allow member states

to restructure their debt.
Reduce the revolving doors
practices between regulators,
supervisory authorities and financial institutions introducing
policies that a ban the common
practice for a number of years
(i.e. 5 years or more)
Monitor that the ultra-accommodative monetary policies do not
create perverse incentives for the
corporate world to pursue massive leverage strategies issuing
unprecedented levels of corporate bonds. This practice is facilitated by the excess of liquidity
and cheap funding guaranteed
by the central banks, and allows
corporations to lever up (e.g.
higher leverage) their balance
sheets and to conduct stockholder-friendly actions, like buying
back stock or paying dividends.
As a result of these strategies, the
corporate world can artificially
increase the profitability of their
businesses (and their earnings
per share) for common stockholders, but without changing
also the fundamentals of their
businesses through investments
in capital expenditures.
Differently from the stock market, the corporate bond market,
in general, is far less liquid and

Is a Slowdown in the Offing?

tends to perform quite poorly
during periods of rising interest
rates and, in general, its securities are not traded in more liquid
exchanges, as stocks are, but they
are traded mostly over the counter in illiquid markets. As stated
by Economist Nouriel Roubini,
private and public debts before and after the financial crisis are held in open-ended
funds that allow investors to exit
overnight. (Roubini, 2015)Prof.
Roubini also added the following: This combination of macro
liquidity and market illiquidity
is a time bomb. So far, it has led
only to volatile flash crashes and
sudden changes in bond yields
and stock prices. But, over time,
the longer central banks create
liquidity to suppress short-run
volatility, the more they will
feed price bubbles in equity,
bond, and other asset markets.
As more investors pile into overvalued, increasingly illiquid assets such as bonds the risk
of a long-term crash increases.
(Roubini, 2015)
Furthermore, as I have stated in
an interview with the Brazilian
news agency, Agncia Estado, in
2011, a generalized approach of
contractionary fiscal policies in
the peripheral European countries, based only on tough national austerity programs; rigid
budget discipline, fiscal consolidation, state-owned assets and
shareholdings dismissals/privatizations, and higher taxation;
with limited or no commitment
also to contra-cyclical measures
towards growth (i.e. investments on innovation, education, infrastructures, tax breaks,
tax incentives, and tax wedge
reduction); effective structural
reforms, spending cuts of nonproductive expenditures (to fill
the competitive gap and to revamp productivity and expectations), and some degree of flexibility to reach budget and fiscal
consolidation targets during
adverse economic cycles, would
eventually turn a bad situation
into a worse one (self-defeating

Slowdown Blues
strategy) or prolonged recession,
or stagnation, or slow and anaemic, and uneven growth (Pezzuto 2011).
The QE program introduced in the
Eurozone in 2015 is very important
to help restore confidence and to affect, over the years, inflation expectations, but it might not be sufficient
to guarantee long-term economic
growth and higher employment unless it is also combined with nonconventional and ultra-aggressive
economic policies, fiscal policies/incentives, industrial and investment
plans, innovation programs, and
radical structural reforms affecting
private firms and public administration productivity, labour market,
welfare systems, free market competition, performance-based compensation, meritocracy, etc.
As I have reported in my paper of
September 2014 titled, Predictable
and Avoidable: Whats Next?, The
peripheral Eurozone countries need
to focus their most critical resources
on long-term development projects,
strategic industries, infrastructures,
new economic and business models,
and innovative cultural and managerial paradigms in order to gain
new competitive advantages and to
achieve global competitiveness. The

shift toward a more integrated and

interdependent world economy,
with falling barriers to cross-border
trade and the progressive globalization of markets and consumer tastes,
are rapidly forcing western economies to rethink the sustainability of
their economic and social models.
Thus, the so-called advanced economies, and in particular the Eurozone
countries, need to pursue their challenging goals of economic revival
while trying at the same time to
avoid generating the following negative consequences.
Destabilizing social cohesion and
trust among member states;
Decreasing consumer and business confidence;
Increasing distrust in national
and regional political and economic leaders;
Rising levels of inequality and social exclusion. (Pezzuto, 2014)

Challenging
ment

global

environ-

There is no doubt that we are currently facing a challenging global

economic cycle. Recently, the IMF
revised downward global growth,
while it also cautioned the Federal
Reserve against raising interest rates
The Global Analyst | JULY 2015 | 47

Is a Slowdown in the Offing?

in 2015 and suggested it to postpone
rate lift-off to First Half of 2016. The
IMF has reported that the dollar is
moderately overvalued and a further marked appreciation would be
harmful. The IMF has also stated:
We still believe that the underpinnings for continued expansion are
in place, and that The inflation
rate is not progressing at a rate that
would warrant, without risk (i.e.
high volatility in the markets, corrections, potential spillover effects on
the emerging markets, flash crash),
a rate hike in the next few months.
That means the Fed might decide to
wait until early 2016, even if according
to Christine Lagarde, IMFs Managing
Director, theres a risk of slight overinflation relative to the central banks
2 per cent target. A stronger dollar,
declining oil investment and a West
Coast port strike in the first quarter
will pull down U.S. growth to 2 per
cent this year, according to the IMF.
Furthermore, she stated that the Feds
policy-setting committee should remain data dependent and defer its
first increase in policy rates until there
are greater signs of wage or price inflation than are currently evident.

Beware of De-coupling risk!

Although the US economy seems to
be in a much better shape than most
other ones, it cannot be considered
in total decoupling from the rest of
the world despite its unique innovative and entrepreneurial spirit and
its numerous competitive advantages and comparative advantages
versus other countries. The current
global slowdown and the numerous
externalities and potential economic,
financial, and geo-political risks arising around the world might have an
important impact even on the US
economy, and mostly on the busi-

48 | The Global Analyst | JULY 2015

The appropriate policy

decision is going to be data
dependent. Our opinions
will shift as the data evolves
there are a set of risks
all of us need to weigh
in judging the appropriate
time. Waiting too long
for normalization can risk
overshooting our inflation
(targets), and beginning too
early could derail a recovery
we have tried to achieve for
a long time.
JANET YELLEN, US Fed Chair
ness interests of multinational firms
operating on a global scale.
The US economy, as some economists fear, might be bracing for one
of the worst first-half performances
since 2011, but even if this will be
confirmed by the data, would be
probably triggered mainly by externalities, global slowdown, high volatility, and structural problems.
The major challenges that the US
probably faces in its effort to revive its
economy, like most of the advanced
countries, include the long-term welfare system sustainability (i.e. pension/retirement plans), its ability to
balance sustained economic growth
and the threat of shadow banking
expansion, a generalized reduced
trust in the financial institutions by
the local consumers and investors as
a consequence of the aftermath of the
2007 2009 financial crisis, the ability
to reduce inequality and strengthen
the economic prosperity and opportunities for its the middle class and
the less educated population, which
has been severely penalized by badly
planned globalization/unfair global
competition, before and after the financial crisis, (i.e. no enforceable
strong
labour
standards, no environmental standards, low cost
productions areas, child labour,
etc.), as Stated
by
President
Barack Obama.
One of the key
challenges for the
US will be related

with the ability to establish new international trade agreements to create a plain field competition that
might further strengthen its global
competitiveness and on the ability
to encourage further expansion of
internal consumption, investments,
markets liberalizations, and innovative business models and global value chains in the fast-growing emerging markets
Another potential risk for the US
Economy could be related to the Federal Reserve rate hike if not properly
managed, although they are very
much aware of this potential risk.
Some analysts say that when the
Fed starts raising interest rates, with
bond prices falling, banks will be left
with depreciating assets (Treasuries)
and stuck with low yielding longterm loans. As the rug is pulled from
under the banks, the housing market might collapse as well, as stated
by Peter Schiff. In fact, if monetary
policy normalization in the USA is
not completed smoothly and carefully, in spite of improved corporate profits and stock market record
highs, there could be the potential
risk of a strong correction in the
markets, since the prices of various
asset classes have been artificially
inflated since 2008 by seven years of
consecutive close to zero percent Fed
Funds rates and three rounds of massive QEs (Pezzuto, 2013). Overall,
there might be challenges along the
way, but I believe that the US economy will remain a leading competitive player in the global arena and an
influential and powerful trendsetter
and benchmark for all economies.
TGA